How Are LLCs Taxed: Everything You Need to Know
If you're thinking, "How are LLCs taxed?" we have the perfect mini-guide lined up for you.3 min read
2. How are LLCs Taxed: Single-owner LLCs
3. How are LLCs Taxed: Multi-Owner LLCs
4. LLCs Can Elect Corporate Taxation
If you're thinking, "How are LLCs taxed?" we have the perfect mini-guide lined up for you. Before your form as an LLC, it is important to understand what that means in terms of your responsibilities. This is particularly true regarding taxation, both at the state and federal level.
Limited Liability Company (LLC)
Like a sole proprietorship or partnership, a Limited Liability Company (LLC) is what's known as a "pass-through entity." This means that unlike a corporation, an LLC is not a separate tax entity. Whatever profits or losses an LLC has will be passed onto its owners. Since these individuals report these values on their personal tax returns, the LLC does not pay federal income tax. However, depending on the location, some LLCs will be required to pay taxes to the state.
How are LLCs Taxed: Single-owner LLCs
For tax purposes, the IRS treats single-owner LLCs as sole proprietorships. This means that as a single-owner LLC, the LLC itself does not need to submit a return or pay taxes with the IRS. Instead, the owner must a Schedule C reporting all profits or losses and submit this information with the 1040 tax return form. Even if profits are left in the LLC's bank account to cover future costs, taxes must be paid on all profits.
How are LLCs Taxed: Multi-Owner LLCs
When an LLC has more than one owner, the IRS treats the company as a partnership for tax purposes. Similar to single-owner LLCs, taxes are paid by the owners. All profits will be shared and these values will be reported on the owners' personal tax returns. Each owner or 'member' will receive a predetermined share of all profits and losses. This is what's called a "distributive share" which will be included in the LLC operating agreement.
When dividing profits between members, most operating agreements will state each member's distributive share in relation to their percentage of the LLC. For example, if Stephen owns 70% of the LLC and Natalia owns 30%, Stephen would be entitled to 70% of the LLC's profits and losses whereas Natalia would be entitled to 30%. When an owner would prefer to split profits and losses in a way that is disproportionate to each member's percentage interest in the LLC, this is what's called a "special allocation."
Like single-owner LLCs, even if the company does not distribute profits to its members, they must pay tax on their portion. This means that even if the LLC leaves all profits in the company, either to purchase inventory or expand, each member is still required to pay taxes on their share of that money. To do so, file Form 1065 with an IRS. This is an informational form to ensure all members are reporting their income correctly.
LLCs Can Elect Corporate Taxation
If the owner(s) of an LLC need to leave a significant amount of profits in the LLC, this is what's referred to a "retained earnings." If you can relate, you may benefit from corporate taxation. If an LLC would like to be treated as a corporation for tax purposes, the Form 8832, Entity Classification Election must be filed with the IRS. Corporate tax rates on the first $75,000 are lower than individual income tax rates. This can result in significant savings.
Additional benefits include:
- The ability to offer owners and employees various tax-related benefits
- The ability to offer owners and employees stock and stock ownership options.
Since LLC members are considered self-employed business owners, taxes will not be withheld. The same is true regarding withheld contributions to Medicare and Social Security systems. This is what's referred to as "self-employment tax." Please note that LLC owners (as well as partners and sole proprietors) must pay twice as much in comparison to employees.
Unlike employees, owners must put away enough to pay the estimated amount of taxes on their share of the profits. Payments are then made quarterly to both the IRS and associated state tax agency. These payments will be made in April, June, September, and January.
If you need help understanding how LLCs are taxed, post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.