Income Tax For LLC: Everything You Need to Know
When determining your income tax for LLC, you should first understand what a limited liability company is and how it functions.3 min read
2. Single-Member LLC
3. Multi-Owner LLC
4. Other Tax Considerations
When determining your income tax for LLC, you should first understand what a limited liability company is and how it functions.
LLC Income Tax Overview
An LLC is a separate tax entity similar to a corporation in its liability yet also like a partnership in its IRS designation as a "pass-through" entity. A "pass-through" entity simply means that the company does not pay corporate tax; rather, the profits, losses, and deductions flow through the business to the members who then file them on their personal tax return. While an LLC does not pay federal taxes, it may be subject to other annual taxes depending on the state in which it operates.
The IRS treatment of your business depends in part on the number of members that make up your LLC.
Since a single-member LLC has only one owner, the IRS views it like a sole proprietorship. Thus, the owner must report all of the profits on a Schedule C to be included with their 1040 personal tax return. Even if you decide to leave the profits in the business bank account for company use, you must still pay income tax on that money.
The IRS treats a multiple-member LLC as though it is a partnership in regards to taxation. The company will not pay taxes on income; instead, the owners are responsible for paying the taxes on the income based on their percentage of the profits, as established in the company's operating agreement. Owners are required to attach their portion of the profits on a Schedule E when filing their taxes.
While it does not need to make payment for taxes, the company is responsible for filing an information Form 1065 tax return with the IRS, which includes Schedule K-1s for each partner to show their individual share of the profit and losses.
Other Tax Considerations
- The profit division between members: A company's operating agreement delineates each member's portion and percentage of the business, which dictates the percentage of profit to which they are entitled. In an LLC, you can split both the profit and losses in a non-proportionate way, an action referred to as a special allocation.
- The taxes that are assessed in the distributive share: No matter how the profits are distributed among the members, the IRS treats each year as though the members received the full distribution amount that was recorded for them. In other words, each member is taxed on their entire distribution share each year even if they have not taken those distributions or if they put them back into the company, such as through buying inventory.
- The forms required to file with the IRS: Even though a multi-member LLC does not pay income taxes, it is legally required to File a Form 1065 informational return with the IRS each year. The IRS uses that form to ensure that each member is reporting their income from the LLC properly on their personal tax return. With this form, the LLC must supply each member with a Schedule K-1 so members can know the profit and losses for their portion that they need to report on their 1040 tax form.
- The consideration of a corporate tax election: For LLCs that anticipate a substantial amount of profits and retained earnings each year, electing a change to corporate taxation might be the best option to lower their tax liability. You can change your tax designation with the IRS by filing a Form 8832, also referred to as an Entity Classification Election.
Starting in the tax year 2018, corporate taxes are at a flat rate of 21 percent. This rate can often be lower for businesses in which the owners may be in the top three levels of taxation for personal tax liability, which can result in tax percentages of 32 percent and higher. A corporation can also allow owners and employees the benefits of tax-advantaged fringe benefits, such as stock options and stock ownership plans.
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