Knowing how does an LLC affect personal taxes is essential for a business owner. A limited liability company, or LLC, is one of the most regular kinds of business entities that small-business owners use when incorporating. When you set up an LLC, the business has its own identity and name that's different from yours. There are many legal protections and financial benefits that go along with that.

As an example, you can do the following:

  • Obtain a business credit card.
  • Get a bank account for the business.
  • Build credit in the LLC's name.

A benefit of LLCs is they don't have to pay a business income tax, as the IRS doesn't look at them as being an individual entity when it comes to tax purposes. All of the money made from the LLC goes directly to you, the owner, so you only will need to pay individual income tax.

Can You File an LLC With Personal Taxes?

The IRS hasn't created a tax return for LLCs yet. The income or loss that's generated by an LLC is subject to taxation on a federal level. However, it's required by the government to use a partnership, personal, or corporate income tax return to report its earnings and losses. If corporate treatment is received, the members of the LLC don't need to report any income on their tax returns.

LLC as a Partnership

If the LLC is treated as a partnership when it comes to federal income tax, all members must report the financial gains and losses of the business on their individual tax returns. All partnership rules must be imposed on the LLC and their members for tax purposes. Partnerships must report any financial activity of the company on IRS Form 1065.

They must also give every partner a Schedule K-1, where respective shares of expenses and income are itemized. When a personal income tax return is filed, all amounts that the partnership gives to you need to be listed on the K-1, and you need to pay the correct tax.

Passive Activity Losses

The IRS won't let you subtract any LLC losses from other sources of income on your personal tax return if you don't actually participate in the LLC's operations. Material participation means you supply at least 500 hours to the business throughout the current tax year, give at least 500 hours of service each year for five out of the past 10 years, or have given 500 hours every year for the past three tax years if the LLC is considered a service-oriented business.

If you don't meet one of these requirements, only losses of the LLC can be used to offset any future business income.

Why Does IRS Disregard the LLC Entity?

The IRS will disregard the LLC if only a sole member exists. That situation would require you to report all expenses and income of the LLC on your individual tax return. This is done by reporting every profit or loss for the LLC on Schedule C, which is filed with IRS Form 1040. If you're the only member of various LLCs, you'll need to file an individual Schedule C for every business that makes at least $400 of earnings per year.

What is the Net Operating Loss of LLC?

LLC members who report a net operating loss from the operations of the business on their individual tax returns may be able to decrease other forms of taxable income by the value of the loss. If there isn't enough income in the present year for the net operating loss (NOL) to offset, the NOL can first be used in the previous two tax years, and any balance that remains can be used against income for up to 20 tax years.

While the NOL is included on an individual tax return, you can general it just from the operations of the LLC or any other business activities that you participate in. As an example, if you're claiming individual itemized deductions that go over your taxable income, the extra deductions don't increase or create an NOL that's generated from the LLC.

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