LLC IRS: Everything You Need to Know
LLC IRS treatment defaults to pass-through taxation like a sole proprietorship or partnership; however, the limited liability company can opt to be treated as a corporation for tax purposes3 min read
2. Multi-Member LLC Income Taxes
3. Electing Corporate Taxation for an LLC
4. Income and Self-Employment Taxes
5. Expenses and Deductions
LLC IRS treatment defaults to pass-through taxation like a sole proprietorship or partnership; however, the limited liability company can opt to be treated as a corporation for tax purposes. This means that the LLC's profits and losses are reported on the tax returns of each of its owners (referred to as members). The LLC itself does not pay income tax but may be subject to an annual state tax.
In addition to this beneficial tax structure, an LLC provides the same limited liability protection as a corporation, which protects personal assets. These advantages have led to the LLC's status as America's most popular business entity.
Single-Member LLC Income Taxes
A single-member LLC is treated as a sole proprietorship by the IRS. The business profits and losses are reported on Schedule C and reported with the 1040 informational return. Even funds that are kept within the LLC must be assigned to a specific member on paper and taxed as income. Single-member LLCs owned by a corporation report income and expenses on IRS Form 1120.
Multi-Member LLC Income Taxes
LLCs with more than one member are treated as partnerships by the IRS, thus subjecting them to pass-through taxation. The member's profit and loss percentage, known as the distributive share, is established in the operating agreement for the LLC. Individual income tax is then assessed on the entire distributive share, even if some of this money is reinvested in the business.
Multi-member LLCs must file annual informational returns using IRS Form 1065 and provide each member with his or her individual profit and loss breakdown on Schedule K-1. This is then filed with the member's Form 1040. An LLC can also submit IRS Form 8832 to be taxed as a corporation.
Electing Corporate Taxation for an LLC
LLCs that plan to retain a substantial portion of earnings within the business may want to consider electing corporate taxation. To do so, simply file IRS Form 8832 and check the box indicating corporate tax treatment. As of 2018, standard (C) corporations are taxed on profits at a flat rate of 21 percent, which is lower than the rate for the top three individual income tax brackets (32 to 37 percent). This may provide an opportunity for LLC owners to save on their taxes. However, corporate profits are first taxed at the corporate rate of 21 percent when they are earned and again at capital gains rates of up to 23.8 percent when distributed to shareholders. Retained corporate earnings and fringe benefits, stock ownership plans, and stock options are not subject to double taxes.
If you decide to elect corporate taxation for your LLC, you must maintain corporate status with the IRS for five years. The IRS will treat your business as a separate entity for tax purposes and hold it responsible for submitting Form 1120 and paying income tax each year. You and the other LLC members are not personally responsible if the business fails to file taxes.
Income and Self-Employment Taxes
Every LLC member must set aside enough money to pay income taxes on his or her share of the business profits. Members estimate their owed tax for the year and then make quarterly payments to the state income tax agency and the IRS. These are due in April, June, September, and January.
Because LLC members are not considered employees, they are not subject to FICA (Social Security and Medicare) tax withholdings. Instead, these are paid from the members directly to the IRS as self-employment taxes. An exception may be made for members who have invested money but do not participate in the direct management of the LLC. Self-employment taxes are reported by members on Schedule SE. Members are subject to the business owner self-employment tax rate of 15.3 percent up to an annual cap and then 2.9 percent for income exceeding that cap.
Expenses and Deductions
Legitimate business expenses can be deducted from your business income on your tax return, which can substantially decrease your taxable income. Examples of these expenses include car and travel expenses, start-up costs, advertising and marketing costs, and equipment. Beginning in 2018, owners of LLCs and other pass-through entities are eligible for a tax deduction of up to 20 percent of their net income.
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