LLC Partnership Taxes: Everything You Need to Know
LLC partnership taxes can be paid like a sole proprietorship, a general partnership firm, or a corporation.3 min read
2. Forming a Limited Liability Company
3. Tax Treatment of LLCs
4. The Advantage of Electing to File Taxes as a Corporation
5. LLC vs. Corporations: Tax Advantages
What Is an LLC?
LLC is a new form of business structure suitable for small businesses. It offers operational flexibility, especially for the purpose of taxation. Its members can choose from several options to pay its taxes for maximum savings.
The IRS does not classify an LLC as a distinct taxation entity. Tax treatment of an LLC depends upon whether it has only one or multiple members and whether it chooses to file taxes as a different business structure.
A multi-member LLC can file its taxes either as a partnership firm or a corporation. Similarly, a single-member LLC can file its taxes as a sole proprietorship, where the business is not considered a different entity from its owner.
Forming a Limited Liability Company
Limited liability companies are formed and governed under state law. You must file articles of organization with the designated agency of the state where the headquarters of the company are located.
In most states, it's either the secretary of state or the Department of Commerce that looks after LLC affairs, including its formation. You must also pay a filing fee along with the formation documents.
The formation process is simple in most states. Usually, you just need to fill out a pre-printed form or follow a sample form.
If there is more than one member in your LLC, you should also prepare an operating agreement. This document should include items such as:
- Rights and responsibilities of the members
- Ownership percentage of each member
- Rules and procedures for managing the company
- Procedures for making major decisions
- Provisions and procedures for adding new members and
- The manner in which the LLC chooses to pay its taxes
After having formed an LLC, you may be required to pay yearly registration fees on an ongoing basis.
Tax Treatment of LLCs
Unless the operating agreement provides otherwise, an LLC is taxed in either one of the following two default manners:
- A single-member LLC pays its taxes as a sole proprietorship, wherein the owner files Schedule C for his personal tax return.
- A multiple-member LLC pays its taxes as a partnership firm and files an informational return in Form 1065.
In addition to the above default tax situations, an LLC can also elect to file its taxes as a corporation.
The Advantage of Electing to File Taxes as a Corporation
The income tax rate for individuals falling under higher income slabs is higher than the highest tax rate applicable to corporations. Thus, if your taxable income, after clubbing your share of company's income, becomes high, it would be beneficial to file a separate tax return for the LLC income.
The major advantage of filing your LLC taxes as a corporation is that you don't have to include the LLC's income on your personal tax return. This keeps your taxable income at the lower end of tax tables.
For example, if you are the only owner, and your company makes a taxable profit of $52,000 in a given year, then you must include the whole of this profit in your personal taxable income and pay taxes at a higher rate. However, if you choose to pay your LLC taxes as a corporation, you need not pay personal income tax on the business profit of the LLC.
LLC vs. Corporations: Tax Advantages
Favorable Tax Rates
The income tax rate for a limited liability company depends upon the taxable income of the owner. If the LLC income is high and the owner's income is less, the LLC can benefit from a lower tax rate compared to that of a corporation.
For instance, on a taxable income of $75,000, a corporation has to pay tax at the rate of 34 percent. On the other hand, an LLC can pass through its income to the owner and pay tax at a personal tax rate of 25 percent only, provided there is no other income included in the owner's tax return.
No Double Taxation
Unlike in case of corporations, an LLC is not subject to double taxation of income.
Some states require corporations to pay franchise taxes. However, there are no such taxes levied on an LLC.
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