LLC Tax: Everything You Need to Know
Before diving into LLC tax, you should know the ins and outs of an LLC.7 min read
2. Sole Owners
3. Multiple Owners
4. Corporate Taxes
5. Income Tax Calculation
6. Self-Employment Taxation
8. States Taxation
9. Taxation of LLCs
10. Income Tax for LLC's classified as Corporations or S Corporations
11. How to form an LLC
12. Partnership Requirements
13. Sole Proprietor Requirements
14. Filing Regulations for Sole-Proprietors
15. Forms to File
Before diving into LLC tax, you should know the ins and outs of an LLC. A limited liability company is an entity comprised of individual members whose personal assets are protected from liability. Further, LLC members qualify for “pass-through taxation,” meaning that each member can use losses and profits of the company on private tax returns. LLCs are not subject to federal taxation. With that, certain states may levy annual taxes on LLCs.
The IRS designates LLCs in the same manner as a partnership or sole proprietorship, but this largely depends on member numbers. In addition, LLCs with a sole owner are treated in the same way as a sole proprietorship, meaning that the LLC does not need to pay taxes or file a return. Instead, sole owners must record profits and losses on a Schedule C and 1040 form.
The IRS treats co-owned LLCs as partnerships for tax purposes.
The IRS classifies LLCs with multiple owners as a partnership. Like sole LLCs, multi-party LLCs don’t need to pay taxes and each member uses Schedule E for private returns. The losses and profits of each are called distributive shares.
According to operating agreements, distributive shares are calculated based on a person’s share in your company. For example, if Bob owns 60 percent of the company, and Lisa owns 40 percent, Bob would be owed 50 percent of the profits, and Lisa would claim 40 percent. A special allocation is necessary for splitting up percentage shares that are not relative to the member’s percentage interest.
With that, the IRS does not recognize special allocation. Each member is taxed on distributive shares, regardless of whether the LLC has paid the money. For example, an LLC may need to leave distributive share money in your company account to expand or buy new inventory, but members are still taxed by the IRS on their personal returns
You need to keep what are called “retained earnings” in your account. Retained earnings are the amount of profit you need to keep in your business account to qualify for election corporate taxation.
LLCs can be designated like corporations for tax reasons via Form 8832 from the IRS.
Corporate income tax rates on are generally lower than personal income tax rates levied on LLC owners. This allows you to save money when you pay your taxes. Further corporate taxes provide owners and workers certain advantages:
- Stock Options
- Ownership Plans
- Advantaged Fringe Benefits
Income Tax Calculation
LLC members are classified as self-employed, which means they are exempt from tax withholding. Rather, members must remember to save enough money to honor tax obligations. Members should plan ahead by calculating how much they owe to the IRS and pay in quarterly installments, including to state officials if state income taxes apply.
Instead, most LLC owners are required to pay these taxes -- called "self-employment taxes" when paid by a business owner -- directly to the IRS.
However, owners that are not active in the LLC -- that is, those who have merely invested money but don't provide services or make management decisions for the LLC -- may be exempt from paying self-employment taxes on their share of profits.
The regulations in the self-employment tax are a bit complicated, but if you actively manage or work in your LLC, you can expect to pay self-employment tax on all LLC profits allocated to you.
Each owner who is subject to the self-employment tax reports the amount due on Schedule SE, which must be submitted annually with his or her tax return.
You can take advantage of various deductions to limit the amount of taxes you pay. You may write off business expenses off business income. This means you can lower the amount of profit reported to the IRS.
Deductible expenses include:
- Travel Expenses
- Start-up Capital
Most states tax LLC profits the same way the IRS does: The LLC owners pay taxes to the state on their personal returns, while the LLC itself does not pay a state tax.
State governments tax LLCs in the same manner as the IRS, with members paying their personal share on state income tax returns. However, certain stage charge additional fees. For instance, California imposes a tax on LLCs that make over $250,000 each year, and the tax varies from $900 to $11,000. Other states may impose annual fees as well.
A few states, however, do charge the LLC a tax based on the amount of income the LLC makes, in addition to the income tax its owners pay.
For instance, California levies a tax on LLCs that make more than $250,000 per year; the tax ranges from about $900 to $11,000.
In addition, some states impose an annual LLC fee that is not income-related.
Taxation of LLCs
When it comes to distributing profits, an owner’s net income is divided based on their distributive share.
The income or loss from the LLC is considered along with other income of the owner (and spouse, if applicable) for the purpose of determining the total tax liability of the owner.
Any profit from the LLC is used to determine the owner's self-employment tax liability; if the LLC has no profit, no self-employment tax is owed for that year.
According to the IRS, LLCs can be taxed in the same league as a corporation or partnership, but such a stipulation applies to LLCs with multiple owners. In the case of sole LLC owners, the company could lose tax distinctions between the owner and LLC.
Income Tax for LLC's classified as Corporations or S Corporations
An LLC may elect to be classified as a corporation or S corporation for tax purposes. Usually, the election is made because it is to the advantage of the business from a tax rate standpoint. The election is submitted through IRS Form 8832 - Entity Classification Election. The LLC then pays income tax based on this new tax status, including state income tax.
How to form an LLC
With an LLC, you can have as many members as needed, or you can be the sole owner. A member is defined as a corporation, partnership or individual, and members can either manage the business or hire someone to manage it for them. In addition, you may choose the tax structure of your business: corporation, partnership or sole proprietorship. It should be noted that LLCs do not dispense stock, but members get to choose how profits are to be partitioned.
A member can be an individual, a partnership or even a corporation.
Members can run the LLC themselves or hire an outside manager.
And LLCs don't issue stock, so profits are divided up any way the members choose, with no need for shareholders' meetings. With that, a corporate structure may be the best option, but this largely depends on your company needs.
LLCs fall under the governorship of state authorities.
With that, many states make the LLC process easier. You can get a form from your state’s LLC office and fill out the form in a matter of minutes. You need an operating agreement if your LLC has over one member.
An operating agreement should have:
- Rights and Responsibilities
- Management Structure
- New Member Procedures
- Tax Structure
Once the documents are filed, pay the annual fee to official register the company. The IRS labels your LLC in the form of partnership status, but for tax reasons only. Sole owners, however, must pay taxes on business income. Both partnership and sole proprietor designations have different tax filing rules.
LLCs must pay annual partnership taxes via Form 1065. If an LLC is subject to partnership tax codes, they do not pay taxes on business income. This type of return is only for data-gathering, and any credit or deductions are reserved for individual returns. LLCS record owner shares on a Schedule K-1 form.
For example, if you and a partner establish a company that yields $100,000 with $60,000 in business expenses to deduct, each party receives a Schedule K-1 with $50,000 of earnings and $30,000 of deductions. Such earnings and deductions need to be reported on an individual tax return.
Sole Proprietor Requirements
For corporate tax elections, the IRS will designate your business as an individual. In essence, you would be liable for any deduction or income via Form 1120. With that, an LLC that fails to file does not mean the members are personally responsible. The one negative is that corporate status means double taxation:
- If the LLC files some corporate returns
- Another layer of taxation levied on member dividends
Owners need to pay dividend taxes on Form 1040.
Filing Regulations for Sole-Proprietors
In a sole proprietorship, you are personally responsible for all tax payments and filings.
Sole proprietors are responsible for any form of taxation. Sole owners must complete a Schedule C to report any deductions or income from your business operations.
Forms to File
A crucial document you’ll need is an operating agreement, which is a document outlining the structure of your business. An operating agreement lists such attributes as:
- Management Structure
- Terms and Conditions
- Roles and Responsibilities
Further, you need Form 1065 at the federal level. The IRS relies on Form 1065 to make sure that each member is paying taxes on their share of LLC income. Members also need a Schedule K-1, so they know about losses and profits. From there, individual member are taxed on 1040 Forms.
If you with LLC tax of any kind, you can post your legal need on the UpCounsel marketplace. UpCounsel is dedicated to help you through the tax process so you can avoid legal complications down the road. Rely on the expertise of our top lawyers to guide your LLC on a pathway to success.