LLC Tax Options: Everything You Need to Know
LLC tax options differ for single-member or multi-member businesses. While LLCs have a default tax status when they're created, business owners may elect a different tax status if they find it more beneficial.3 min read
2. How LLCs are Taxed
3. Choosing Corporate Tax Status
4. Choosing S Corp Status
Updated November 18, 2020:
LLC tax options differ for single-member or multi-member businesses. While LLCs have a default tax status when they're created, business owners may elect a different tax status if they find it more beneficial.
LLCs have some flexibility regarding tax treatment. Business owners can choose different tax classifications in order to save money for the company and its owner(s), or members. If you operate an LLC, you may be taxed as one of the following:
- Sole proprietorship
You'll file the appropriate forms with the IRS to make your tax selection.
Unlike corporations, LLCs are not treated as separate taxable entities by the IRS. LLCs give their members personal liability protection but without the formalities, red tape, and complicated paperwork that can be such a burden for solo entrepreneurs, small businesses, or start-ups.
How LLCs are Taxed
Unless you choose otherwise, the IRS will tax you by default based on how many members are in your LLC. Your LLC will be taxed like a sole proprietorship if you're the sole member, and the IRS will tax your LLC like a partnership if you have multiple members.
Single-member LLCs, since they're treated like sole proprietorships for tax purposes, file Schedule C on a member's personal tax return. The business itself doesn't file taxes, only members do. Profits or losses are reported on Schedule Cs.
Members also pay self-employment taxes on business income. However, if you created an LLC for passive income purposes, like real estate investment, you don't pay self-employment taxes on the profits. Instead, you use Schedule E to report passive profits.
Multi-member LLCs that are taxed as partnerships file form 1065, or an information return, with Schedule K-1s for every member. Form 1065 is used to ensure that all LLC members properly report their business income. Members pay their share of self-employment taxes based on their share of business profits.
Choosing Corporate Tax Status
While sole proprietorships and partnerships are the default classes, LLCs can choose to be taxed like corporations by filing form 8832. LLCs that choose this status file corporate tax return 1120 and are taxed at the corporate rate.
Business profits are distributed to members as dividends. For LLCs treated as corporations, dividends are subject to taxes at the qualifying dividend rate, so corporations are taxed twice: once at the individual level and once at the corporate level.
An LLC's profits aren't subject to self-employment taxes. LLCs that are taxed like corporations are responsible for payroll taxes paid to members who work as employees in the company.
If you'd rather not distribute profits to members but instead keep them in the company, a corporate status could work for you. In this instance, the business pays taxes on the profits, but individual members don't pay taxes on money that stays in the business.
Choosing S Corp Status
An LLC can also choose to be treated as an S corporation, where the company's profits aren't subject to a corporate tax. Individual members in the S corp pay taxes on their share of company profits. Any LLC members who work in the business must receive a reasonable salary for his or her work, and the business pays payroll taxes on these wages. Wages are reported as ordinary income and are separate from the distribution of profits and losses.
The S corp files a corporate tax return, but it doesn't pay any taxes. Instead, members report their share of the business's profits and losses on their own tax returns.
Regarding partnership or S corp taxation, members are personally and individually liable for taxes on their share of business profits, whether profits are distributed to them or not. Many operating agreements (where the business is taxed as an S corp or partnership) contain a clause concerning the minimum distribution of profits to cover each member's tax liability portion.
While the IRS will classify your LLC in a default category when you create it, you can elect for a different status for tax purposes. Because tax law can be complex, you might consider consulting with a tax or financial professional to ensure you're making the best decision for your business.
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