LLC Income: Everything You Need to Know
LLC income usually stems from the amount invested in the LLC. All income and losses flow from the business to individual members to file on personal taxes.3 min read
LLC income usually stems from the amount you invest in the LLC. All income and losses flow from the business to individual members to file on their personal taxes, otherwise known as pass-through taxation. When it comes to LLC taxation, the IRS designates your business as a partnership or sole-proprietorship. This means that the LLC does not pay business taxes and would not have to submit a tax return to the IRS. As a sole LLC owner, you would note all profits and losses on Schedule C and include it with the standard 1040 tax return.
- Note: If you leave business profits in your business bank at the end of a year to cover potential expenses, or to grow the business itself, you need to pay income taxes on the money.
The IRS treats multi-member LLCs as partnerships when it comes tax classification. As is the case with sole-member LLCs, co-ownership LLCs do not pay business income taxes. Instead, the owners would pay taxes on their profit shares via Schedule E attached to the standard 1040.
Under an LLC, you do not receive a paycheck. Rather, all members have capital accounts, which comprises their ownership share in the LLC. When you become an LLC member, you need to give money to the capital account, and you may draw out the money when you need it in the form of a distribution. The money you take out of the account is the percentage share from the LLC.
Distributive Share Parameters
Every LLC member share of losses and profits, also known as distributive shares, needs to be established within the operating agreement of your LLC.
- For instance, if Bill owns 60 percent of the business, and Briana owns the remaining 40 percent, Bill is entitled to 60 percent of all losses and profits, while Briana gets the remaining 40 percent of profits and losses.
If you prefer to divide profits and losses in a disproportionate manner, this is called a special allocation, and it must be detailed in your operating agreement.
In regards to distributive shares, the IRS designates that all LLC members receive their right shares every year. This means that members must pay taxes on whole shares, regardless of whether or not they receive all of their shares in a year. Even if members must leave profits in the business to grow the business or purchase inventory, all members are liable for income taxes on their share of the money.
LLCs do not pay income taxes, but they still must submit Form 1065 to the IRS. It is the same form that partnerships file, and it is simply an information-based return that the IRS uses to make sure that all members report income accurately on their individual tax returns. In addition, the business must also give each member a Schedule K-1, which details shares and losses of LLC members. Therefore, all members report such loss and profit noted from Schedule K-1 on Form 1040 with Schedule E included.
If you need to retain a significant amount of profit within your business, also called retained earnings, you would benefit from choosing a corporate tax classification. An LLC can be taxed as a corporation through the filing of Form 8832.
- Note: Beginning in 2018, all C corporations are taxed at 21 percent on all profits.
The aforementioned rate is lower than individual tax rates, ranging from 32 to 37 percent, which would otherwise apply to owners at various income tiers. Therefore, owners save money overall by choosing a C-corp tax classification. With that, such savings could be elusive because C-corp distribution money is open to double taxation in the following forms:
- 21 percent corporate tax
- Shareholder individual tax at capital gains tax rates, which could run up to 23.8 percent.
However, retained earnings are not open to double taxation. Also, corporate taxation election may allow LLCs to give employees and owners various benefits in the form of:
- Stock plans
- Stock ownership plans
None of the aforementioned benefits are open to double taxation.
- Note: The IRS designates LLC members as self-employed instead of being employee of the LLC.
If you have more questions on how your LLC income would be taxed, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s lawyers will give you vital information on how your LLC income would be taxed, including various tax-savings strategies you can use to your advantage. Also, they will help you determine if a corporate tax classification would be the right move for your LLC.