LLC Taxation – All Your Questions Answered

If you have ever looked into forming your own startup (or you already own your own business) – you’ll likely want to know the rules for LLC taxation. An LLC is also known as a limited liability company.

According to the IRS, an LLC is not like a corporation in one key way – it’s seen not as a separate tax entity, but rather as a “pass-through entity”. Other business arrangements that fall into this IRS classification include sole proprietorships and partnerships.

The IRS assumes that both losses and profits pass through the LLC to the individual owners/members. Interestingly, LLCs do not pay federal taxes, but some states do tax them.

Why Don’t LLCs Pay Income Taxes?

Interestingly, the IRS treats LLCs like a partnership or sole proprietorship. While the LLC itself does not file federal income taxes, if you’re the owner, you still need to fill out the proper forms and report the LLC’s overall income.

What About Single-Owner LLCs?

If you’re the only owner of a limited liability company, the IRS really views you as a sole proprietorship. You don’t need to have the LLC file taxes, or pay taxes.

However, this is somewhat misleading, as you should still use Schedule C to report all losses (or profits) of the LLC. Submit this with your 1040 tax return, and be sure that you personally pay taxes for the LLC.

Like we said – it’s confusing. For this reason (and others) – we highly recommend utilizing a qualified tax professional to file your income taxes.

What About LLCs With Multiple Owners?

This is where things get a bit more complicated. The IRS essentially treats LLCs with multiple owners as partnerships.

This means the LLC still does not pay taxes – but rather each owner pays taxes on their portion of the profits. This gets reported on your personal income tax returns, along with the Schedule E form.

On the LLC operating agreement, each member should have a distributive share designated. This is the % of profits each member should get, in perpetuity.

One important wrinkle here, is that each member has to pay their taxes on income from the company – even if that income is left in the LLC’s bank account. Otherwise, there are a huge number of ways citizens may try to cheat on their income tax – exactly what the IRS does not want to happen.

LLCs in this form should also use Form 1065, as well as Schedule K-1. Each member uses K-1 to determine what to report on their 1040, which also needs to have Schedule E included when these forms are filed with the IRS.

What About Corporate Taxation?

If you need to keep a lot of money in the LLC’s bank account – consider electing corporate taxation. Basically, this means the IRS will treat you like a corporation – not a partnership.

To do this, file IRS Form 8832, and make sure you check the corporate tax treatment box. This corporate tax change means that all of the LLC’s profits will be taxed at a flat rate of 21%.

This classification as a C corporation saves the individual members quite a bit of money. 21% is lower than the top three tax brackets for individuals, so this can (hypothetically) save up to 16% annually for each owner of the LLC.

However, this is where double taxation comes into play. You have to pay the corporate tax – then each individual needs to pay capital gains taxes on any money the owners receive.

Retained earnings are not double taxed, however. Additionally, there are numerous other forms of income for LLC owners (such as the distribution of stock options) – which are also not subject to double taxation.

How To Estimate And Pay Income Taxes For LLCs

Things get more confusing for LLC owners when it comes to estimating and paying their own taxes. Since owners of LLCs are not technically employees, no taxes are traditionally withheld.

While this sounds good in theory, the reality is you will need to set aside money to pay taxes. You should do this quarterly, not only with the federal goverment, but also with your local state government.

…And Then There Are Self-Employment Taxes

Another unfun wrinkle comes in the form of paying so-called “self employment” taxes. Essentially, LLC members need to pay towards social security and medicare programs.

Normally these taxes are withheld from paychecks, but since LLC owners are not technically employees – you will need to pay the IRS directly. If you are an active member of the LLC, you will need to pay these taxes.

However, a weird rule allows non-active members of an LLC (usually investors) – to avoid paying these taxes. To avoid a potential audit (or other issues) – it’s usually better to pay these taxes, just in case.

Using form Schedule SE, you report these taxes to the IRS. The news gets worse if you’re an LLC owner, as you have to match any self employment taxes filed by employees.

It gets even more confusing, because you can then deduct half of the amount from your income. The rate of these taxes is 15.3% of your net income.

However, once you are past the threshold, you only pay 2.9% on additional income. To get the most accurate numbers, consult the IRS website for these threshold amounts.

Other Factors To Consider

Forming an LLC can be a very fun (and very profitable) endeavor. However, an LLC’s income is still taxable, and it is very important to make the proper tax payments to Uncle Sam.

Business profits may be technically different than personal income, but it still needs to be reported. We recommend hiring certified CPAs, to help you avoid any tax liability.

Business owners have numerous tax headaches to deal with. Business expenses are often deductible, but you are also paying taxes on your share of the profits of the business.

Additionally, for income tax purposes, you may not even be classified as a corporation. If you’re a franchise of a brand, you may have to pay a franchise tax as well.

A single-member LLC is treated differently than a corporation, but this can also be undone, by classifying your LLC as a corporation, on the approriate taxpayer form. Your personal tax return will also likely be very complicated, even if you only have a small share of the LLC itself.

Each individual of a multi-member LLC also needs to have their proper allocation of profits determined – all with the right paperwork filed. The business income is also subject to state tax – which we have barely even covered here.

You are also subject to individual income tax – even if you’re not the sole proprietor of a business. Needless to say, this is the best example of why we always recommend utilizing a qualified tax professional for your income taxes.

The Bottom Line On LLC Taxation

All businesses are required to file thorough and proper taxes – there are no exceptions. While your state may impose its own rules, federal income tax rules are clear.

The corporate tax rate typically changes often, and many try to avoid the corporate tax (like Apple). We don’t recommend this for anyone, even if some of these bigger companies can get away with it (at least temporarily).

References

  1. “10 Facts About LLC Taxes You Need to See.” BestLLCServices.com, 25 Sept. 2020, bestllcservices.com/llc-taxes/.
  2. “4 Tax Possibilities for Your LLC.” Business Class: Trends and Insights | American Express, www.americanexpress.com/en-us/business/trends-and-insights/articles/4-tax-possibilities-for-your-llc/.
  3. “The ABCs of LLCs [All LLC Questions Answered]: Lyda Law Firm.” Lyda Law Firm LLC, www.lydalawfirm.com/llc.
  4. Nellie Akalp. “What Is the LLC Tax Rate?: The How, What, and Why of LLC Taxation.” CorpNet, 30 Dec. 2019, www.corpnet.com/blog/what-is-the-llc-tax-rate/.
  5. Akalp, Nellie. “The 5 Biggest Tax Differences Between an LLC and Corporation.” Entrepreneur, 24 Oct. 2014, www.entrepreneur.com/slideshow/299832.
  6. “Annual Report and Tax Instructions.” Division of Corporations – State of Delaware, 24 Feb. 2020, corp.delaware.gov/paytaxes/.
  7. “The Complete Guide to LLC Taxes (Limited Liability Corporations): Bench Accounting.” Bench, bench.co/blog/tax-tips/llc-taxes/.
  8. “The Complete Guide to LLC Taxes (Limited Liability Corporations): Bench Accounting.” Bench, bench.co/blog/tax-tips/llc-taxes/.
  9. Diana Fitzpatrick, J.D. “How LLC Members Are Taxed.” Www.nolo.com, Nolo, 13 July 2020, www.nolo.com/legal-encyclopedia/how-llcs-are-taxed-29675.html.
  10. Elliott, Candice. “LLC vs S Corp: The Amazing Tax Benefits Of Having a Business.” Listen Money Matters, 22 Aug. 2020, www.listenmoneymatters.com/llc-vs-s-corp/.
  11. “Federal Income Taxation of LLC Members.” Morris Manning & Martin, LLP, www.mmmlaw.com/media/federal-income-taxation-of-llc-members/.
  12. “Filing LLC Taxes.” Findlaw, 18 Jan. 2018, www.findlaw.com/smallbusiness/incorporation-and-legal-structures/filing-llc-taxes.html.
  13. Fontinelle, Amy. “Become an LLC and Save Taxes Under Trump (Maybe).” Investopedia, Investopedia, 28 Aug. 2020, www.investopedia.com/taxes/how-becoming-llc-could-save-taxes-under-trump/.
  14. “A Fresh Look at Taxation of LLC Versus C Corp for Startups.” Withum, 10 Nov. 2020, www.withum.com/resources/taxation-llc-versus-c-corp-for-startups/.
  15. FreshBooks. “Tax Classifications for LLC: Everything You Need to Know.” FreshBooks, 20 July 2020, www.freshbooks.com/hub/taxes/tax-classifications-llc.
  16. Henricks, Mark. “What Are the Tax Benefits of an LLC?” SmartAsset, SmartAsset, 14 Apr. 2020, smartasset.com/taxes/what-are-the-tax-benefits-of-an-llc.
  17. “How Are LLCs Taxed?: Limited Liability Company Tax Information.” Legal Templates, 14 Dec. 2020, legaltemplates.net/resources/business/how-are-llcs-taxed/.
  18. “How Are LLCs Taxed?” Arizona LLC Law, 6 Oct. 2018, www.keytlaw.com/azllclaw/forming-llcs/llc-tax-methods/.
  19. “How Do LLCs Get Taxed? Choosing a Tax Structure for Your LLC.” Affordable Legal Services, Free Legal Documents, Advice & Ask a Lawyer, www.rocketlawyer.com/article/llc-tax-information.rl.
  20. “How Is an LLC Taxed?” Business.com, www.business.com/articles/limited-liability-company-taxes/.
  21. “How Is an LLC Taxed?” Business.com, www.business.com/articles/limited-liability-company-taxes/.
  22. “How Is an LLC Taxed?” LegalNature, www.legalnature.com/guides/how-is-an-llc-taxed.
  23. Howell, Rod. “Taxation of an LLC Corporation or Partnership.” Small Business – Chron.com, Chron.com, 21 Nov. 2017, smallbusiness.chron.com/taxation-llc-corporation-partnership-60046.html.
  24. Jflawfirm.com, jflawfirm.com/llc-taxation-vs-s-corporation-taxation-what-is-the-difference/.
  25. “Limited Liability Company (LLC).” Internal Revenue Service, www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-llc.
  26. Linsey Knerl. “LLC Taxed as S Corp: The Basics.” Collective, 3 Dec. 2020, www.collective.com/guides/business-formation/llc-taxed-as-s-corp/.
  27. “LLC Electing S Corp Tax Status: An Option You May Not Know You Have.” Bizfilings, www.bizfilings.com/toolkit/research-topics/managing-your-taxes/federal-taxes/llc-electing-s-corp-statusthe-best-of-both-worlds.
  28. “LLC or S Corporation: What’s Better for Your Business?” Business News Daily, www.businessnewsdaily.com/15339-llc-vs-scorporation.html.
  29. “LLC Tax Benefits, Deductions & Loopholes: 10+ Tips To Know.” IncNow, www.incnow.com/tax-tips/.
  30. “LLC Taxation Options.” NCP, 25 Nov. 2020, www.nvinc.com/llc-taxation-options/.
  31. “LLC Taxation: See How an LLC Is Taxed in the U.S.” Easy LLC®, 23 Sept. 2019, www.easyllc.com/learn/llc-taxation/.
  32. “LLC Taxed As Corporation: UpCounsel 2020.” UpCounsel, www.upcounsel.com/llc-taxed-as-corporation.
  33. “LLC Taxes.” Limited Liability Company (LLC) Tax, www.koontzparkin.com/limited-liability-company-llc-tax/.
  34. Murray, Jean. “LLC Tax Advantages and Disadvantages Explained.” The Balance Small Business, www.thebalancesmb.com/what-are-the-tax-advantages-and-disadvantages-of-an-llc-397768.
  35. Murray, Jean. “Why Not All LLCs Pay Taxes the Same Way.” The Balance Small Business, www.thebalancesmb.com/how-does-a-limited-liability-company-pay-income-tax-398990.
  36. Nicolosi, Phil. “5 Common LLC Taxation Questions.” Phil Nicolosi Law, www.internetlegalattorney.com/5-common-llc-taxation-questions/.
  37. Ninan, Gigio. “Council Post: Should You Form An LLC Or An S-Corp, And What’s The Difference?” Forbes, Forbes Magazine, 29 May 2018, www.forbes.com/sites/forbesnycouncil/2018/05/29/should-you-form-an-llc-or-an-s-corp-and-whats-the-difference/.
  38. “How Limited Liability Companies (LLCs) Are Taxed.” Bplans Blog, 14 Oct. 2015, articles.bplans.com/how-limited-liability-companies-llcs-are-taxed/.
  39. “Overview of Tax Implications of LLCs and Corporations.” Bizfilings, www.bizfilings.com/toolkit/research-topics/managing-your-taxes/overview-of-tax-implications-of-llcs-and-corporations.
  40. “Partnership & LLC Taxation.” Journal of Accountancy, www.journalofaccountancy.com/topics/tax/partnership-llc-tax.html.
  41. “Partnership and LLC Taxation.” The Tax Adviser, www.thetaxadviser.com/topics/passthroughs/partnerships.html.
  42. “Will an LLC Help Lower Your Business Taxes.” Small Business Trends, 22 Dec. 2018, smallbiztrends.com/2011/11/will-llc-lower-business-taxes.html.
  43. “Tax Forms for an LLC: Federal Forms LLCs Should Know About.” Patriot Software, 27 Feb. 2018, www.patriotsoftware.com/blog/accounting/llc-tax-forms/.
  44. “Taxation of Limited Liability Companies.” Edward Allen Law, 4 Aug. 2015, www.edwardallenlaw.com/taxation-of-limited-liability-companies-llcs/.
  45. Thienel, Stephen. “Should My LLC Be Taxed as an S-Corporation?” Thienel Law – Columbia, Maryland Business Attorney, Thienel Law – Columbia, Maryland Business Attorney, 30 Oct. 2018, www.thienel-law.com/blog/2018/10/28/should-my-llc-be-taxed-as-an-s-corporation.
  46. TRUiC. “LLC Tax Guide.” Howtostartanllc.com, TRUiC, 13 Nov. 2020, howtostartanllc.com/taxes/llc-taxes.
  47. TurboTax – Taxes, Income Tax. “LLC Tax Filing Rules.” TurboTax Tax Tips & Videos, turbotax.intuit.com/tax-tips/small-business-taxes/llc-tax-filing-rules/L39E29kPR.
  48. “U.S. Taxation of U.S. Limited Liability Companies.” NYSSCPA, www.nysscpa.org/news/publications/the-trusted-professional/article/u.s.-taxation-of-u.s.-limited-liability-companies-(llcs).
  49. Undefined. “Brex Log: Understanding and Tackling LLC Taxes in No Time Flat.” Brex, Brex, 31 July 2020, www.brex.com/blog/llc-taxes/.
  50. “US LLC Taxes for Non-US and US Entrepeneurs • Online Taxman.” Online Taxman, 7 Apr. 2020, onlinetaxman.com/us-llc-tax-haven-for-foreigners/.