While choosing a business entity for a company, the tax structure is crucial. Tax plays a direct or indirect role in that decision. Whether you choose an S corporation, C corporation, limited liability company (LLC), or any other legal entity.
And this guide is going to help you go through the basics of LLC tax structures.
Most of the small businesses and startup use LLC services like Incfile and Zenbusiness or DIY in the United States. It helps their newly established business to get a legal status with the lesser tax burden on their shoulders.
An LLC is a type of business structure registered under state statute. Contrary to sole proprietorship and most of the corporations, an LLC provides personal liability protection to owners with multiple tax options and benefits.
However, LLC taxation depends on whether a company is registered as a single-member LLC or multi-member LLC. Morever, it also depends on the LLC tax structure. In short, how much tax you can save depends on if an LLC has one member or several members.
This LLC tax guide will talk about LLC tax options, pros and cons, specific situations, state taxes, and federal taxes in detail. Keep reading till the end to know how LLC tax options could benefit you.
How LLCs are Taxed?
There is a variety of business taxes that the owners of an LLC might be responsible for. Federal, state, and local income taxes represent an immense burden for most business owners. How you file and pay income taxes depends on the number of LLC members. Your LLC may have one owner (a single-member LLC) or multiple owners (a multi-member LLC).
Single-Member LLCs are Taxed as Sole Proprietorship
The Internal Revenue Service (IRS) treats a single-member LLC as a disregarded entity and subjects it to pass-through taxation for federal income tax purposes. A disregarded entity or pass-through taxation means that the income and expenses are reported on a member’s (owner) tax return. The LLC itself do not files a separate income tax return.
How does Pass-Through Taxation Work?
Expressly, as your LLC’s sole owner, you will be taxed as a pass-through entity just like a sole proprietorship. The following forms will be used to report your business income and expenses to IRS;
- Form 1040: U.S. Individual Income Tax Return
- Schedule C: Used to determine the amount of self-employment tax that one owes to IRS for Medicare and Social Security taxes
If an LLC generates a net profit in a fiscal year, the owner will pay taxes according to his/her personal income tax rate. On the contrary, if an LLC faces a loss in a fiscal year, the owner can deduct this loss from his/her personal income.
The tax process usually works the same at the local and state levels. For instance, John Kessel, the sole owner of “Beauty & Beyond LLC” in Georgia, will report his business income on his federal and state personal tax returns.
By the way, you can also go through our how to create a new LLC guide to learn more about LLC taxes by state.
Multi-Member LLCs are Taxed as Partnership
IRS, by default, taxes multi-member LLCs like a partnership and treats them as pass-through entities for federal income tax purposes. This means the LLC doesn’t have to pay taxes; instead, each member pays taxes in proportion to their ownership.
How does Pass-Through Taxation Work in Multi-Member LLC?
In a multi-member LLC, the various tax forms are used. LLC gives the following forms to each member by March 15th of each year;
- Form 1065: U.S. Return of Partnership Income
- Schedule K1: Summarizes each owner’s share of LLC income, credits, losses, and deductions.
Then members file the following forms with IRS;
- Form 1040: U.S. Individual Income Tax Return
- Schedule E: Used to report income for individual partners in a partnership and for owners of S corporations.
- Each owner will attach their Schedule K-1 to their personal income tax return filed with the IRS.
To understand it better, let us take an example—Emma Brown and Mayra Smith each share 50% ownership in “Foodies LLC” in Illinois. Emma and Mayra are both responsible for paying taxes on half of the business’s profits. Both can also individually claim half of the LLC’s tax deductions and tax credits. Moreover, each of them can write off half of the losses.
LLCs that Choose to be Taxed as a Corporation
Under specific circumstances, an LLC can opt for C-corporation or S-corporation tax structure regardless of its number of members. What is means is that a single-member LLC and multi-member LLC.
Both can be taxed as S corp or C corp. However, members’ voting and consent are required to choose S or C corp tax structure. Moreover, this change needs to be mentioned in the LLC operating agreement.
What does an LLC Need to be Taxed as C Corp?
An LLC needs to file Form 1120, U.S. Corporation Income Tax Return with the IRS to be taxed as a C-corporation. By making this change, your LLC will be subject to the 21% federal corporate tax rate. The taxes will be filed using Form 1120, U.S. Corporation Income Tax Return. In addition to this federal tax, your LLC also needs to pay state and local corporate taxes.
What does an LLC Need to be Taxed as S Corp?
Apart from how salary and distributions from the business are taxed, an S-corp is taxed like a pass-through entity. All LLCs electing as an S corporation need to file Form 2553.
After that, they must file Form 1120-S, U.S. Income Tax Return for an S Corporation with the IRS to elect S-corporation tax status. Credits and deductions of each owner’s pro-rata share of corporate income will be reported on Schedule K-1 (Form 1120-S).
To learn more about how LLC is taxed as S corp in detail, read this article.
Will Corporate Tax Status Affect LLC’s Legal Status?
No, it does not affect your LLC from a legal standpoint. Your business will continue to operate as an LLC. Consult with a tax professional to see if corporate tax status is doable for your LLC. If you hire the best LLC services reviewed here, most of them like ZenBusines, offer tax consultation with a certified CPA as a part of their LLC formation packages.
LLC Annual Fee
In some states, such as California, LLCs have to pay an annual fee, separate from state tax. Therefore, take these expenses into account while making budgeting decisions and selecting your business structure.
LLC Self-Employment Taxes
Though an LLC’s members are not employees by law, under the Self Employment Contributions Act (SECA), the members still need to pay social security and Medicare taxes to the IRS. Schedule SE helps you calculate the tax liability that you have to attach to your tax return. Generally, the total self-employment tax is 15.3%. You can break it into the following parts:
- 0.9% Medicare surtax on earnings over $200,000
- 2.9% Medicare tax on all earnings
- 12.4% social security tax on earnings up to $137,700
LLC Payroll Taxes
The LLCs that have employees, must collect and pay payroll taxes. This includes social security taxes, unemployment taxes, and medicare taxes. The following IRS forms are used to file Payroll taxes:
- Form 940: Used to report an employer’s unemployment tax obligations (filed annually).
- Form 941: LLCs use this form to report withheld income taxes and the employer and employee’s share of Medicare and Social Security taxes (filed quarterly).
The IRS utilizes a pay-as-you-go system for payroll taxes instead of tax forms. Therefore, you have to deposit your payroll taxes according to the schedule set by the IRS throughout the year. You can deposit the taxes on the Electronic Federal Tax Payment System (EFTPS).
In addition to federal payroll taxes, your states and local governments also charge payroll taxes. Here, employer taxes required to be submitted directly to the tax agency. And payroll taxes are the employee’s responsibility. Hence, you need to make the required withholdings and remit payment to the state or local agencies.
LLC Sales Taxes
If your LLC is based on service or it sells taxable goods, you have to collect sales tax from your customers. This tax needs to be remitted to the state or local tax agency. Forty-five out of fifty states impose a sales tax. Even the states such as Alaska that do not impose a state sales tax, several cities within those states charge local sales tax.
Every state and locality has different rules for sale tax. You can contact the concerned departments to know the specifics.
An LLC offers more tax options and advantages than any other business structure, such as a corporation. And to get full advantage of this chance, choose your tax option wisely.
Moreover, stay organized to stay compliant with the state and federal agency by filing the correct forms. And always pay your LLC taxes at the correct time. If you could not pay some of your taxes in time, request an extension avoid any penalties. For more of LLCs, to forget to go through our detailed guideline.
Aisha Noreen is an owner of a small business with more than 9 years of experience in the marketing industry. With the wisdom of an old soul, she always seeks innovation and mind-blowing ROI techniques. Her unique approach helped many small businesses thrive and she can surprise you in many ways as well. Believe it or not, her energy, passion, and creativity are contagious enough to transform your business and take it to another level.