LLC Tax Obligations: Everything You Need to Know
Tax obligations are determined by the number of members in your LLC and elections made, therefore your company will either be taxed as a sole proprietorship, a partnership, or a corporation.3 min read updated on February 01, 2023
What Is an LLC?
An LLC or "limited liability company" is a specific business structure that offers protection among owners. Owners or "members" benefit from personal liability protection in relation to company debts. Although LLCs are protected as if they were a corporation, they utilize a unique tax system. While operating an LLC, all profits and losses are passed onto the owners.
This means that all profits and losses pass through the entity and are reported on the individual tax returns of each member. By understanding what is required of your LLC in terms of taxation, you reduce your risk of being audited by the IRS. All members should be aware of their personal tax rates.
How LLC Members Are Taxed
Unlike a corporation, an LLC is not a distinct tax entity. Instead, LLCs are referred to as "pass-through" entities, such as a sole proprietorship or partnership. Since profits and losses are passed onto each member, the LLC is not taxed at the federal level. However, some states may also charge a yearly tax, also known as a franchise tax.
Whether your LLC is a sole proprietorship or a partnership for taxation will depend on how many members it has.
- If you are a single-member LLC, you will be taxed as a sole proprietorship. You will need to report all personal profits and losses from the LLC on your 1040 tax return.
- If you own a multi-member LLC, you will be taxed as a partnership. Even though the LLC will not be taxed itself, the company will need to file Form 1065. Profits are distributed based on member interest. For example, if you own 40 percent of the business, you will be entitled to 40 percent of all profits and losses.
LLC can also seek corporation election for tax purposes. Please note that as of 2018, C-corporations are taxed at a rate of 21 percent on all profits. This rate is still lower than all three individual tax rates, which range from 32 to 37 percent.
LLC Tax and Reporting Requirements
As mentioned above, your LLC can elect to be treated as a C-corporation or an S-corporation in terms of taxation. To do so, you will be required to file Form 8832 and once approved, you will then need to file Form 2553 for S-corporation election. In this case, your LLC would file an S-corporation tax return, preparing a schedule K-1 for each member.
When you plan ahead, you can either eliminate or significantly reduce the effects of double taxation. It's also important to remember that only dividends are taxed twice. These are the amounts that are paid to each owner, which are deducted from the LLC's income before a tax value is calculated.
If your LLC has employees, know that you must withhold all federal income tax from an employee's wages. This amount will depend on varying factors, including the wages paid and social security deductions. Following these deductions, your LLC must file a return and then deposit these funds into a bank. Each employee is also entitled to an annual statement. This will identify the wages paid and the taxes that were withheld.
As an LLC, you should also be aware of a franchise tax. This is imposed on select businesses that operate in certain states. This is typically a flat fee that differs from state-to-state, however, other states charge an amount based on the LLC's capital income. In most states, this fee is $100, but in California, this fee is $800 per year. If you are required to pay this tax and fail to do so, you can experience severe penalties. Your LLC could even face dissolution.
There are also taxes associated with owning property. Your LLC may be taxed on real property (land, buildings, structures), tangible personal property (cars, equipment, machinery), and intangible personal property (such as a company's goodwill).
Understanding your tax obligations can ensure that your LLC remains in good standing and is able to achieve long-term success. If you do not understand your LLC tax obligations, it is best to seek assistance well in advance. That way, you can maintain organized records and ensure that your fees are paid and that your paperwork is filed on time.
If you need help with your LLC tax obligations, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.