Key Takeaways

  • LLCs are flexible in how they're taxed: by default as a sole proprietorship or partnership, or optionally as a corporation or S corp.
  • The IRS allows LLCs to elect their preferred tax classification using Forms 8832 (corporation) or 2553 (S corp).
  • Different LLC types exist beyond tax status, including single-member, multi-member, series LLCs, and more, each with distinct operational characteristics.
  • Tax treatment influences liability, self-employment taxes, and how profits are distributed or retained.
  • Some LLC structures are better suited for real estate, venture capital, or specific industries.

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.

About LLCs

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
  • Partnership
  • Corporation

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.

Types of LLC Structures

When forming a limited liability company, it’s important to understand that “LLC” refers to a legal structure, not a tax classification. There are several types of LLC structures that serve different business needs. Each option offers limited liability protection, but operational flexibility and ownership may vary.

Common LLC options include:

  • Single-Member LLC (SMLLC): Owned by one individual or entity. It is the simplest form and is taxed as a sole proprietorship by default.
  • Multi-Member LLC: Owned by two or more individuals or entities. It is taxed as a partnership unless otherwise elected.
  • Member-Managed LLC: All members participate in daily operations and management decisions.
  • Manager-Managed LLC: Members appoint a manager (who may or may not be a member) to handle business operations.
  • Series LLC: Allows for the creation of multiple “series” or divisions under a single LLC umbrella, each with separate assets and liabilities. This is particularly useful in real estate or investment businesses.
  • Professional LLC (PLLC): Designed for licensed professionals such as doctors, lawyers, and architects. Only certain states permit PLLCs.
  • Anonymous LLC: Allows members to maintain privacy by not listing their names in public records, often achieved through legal structuring in privacy-friendly states.
  • L3C (Low-Profit LLC): Combines a mission-driven nonprofit model with for-profit status, typically used for social enterprises.

Choosing the right LLC type depends on your business model, regulatory environment, and long-term plans.

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.

LLCs and Employment Tax Obligations

Regardless of how your LLC is taxed, if it has employees (including members drawing a salary), it may be required to comply with employment tax obligations. These can include:

  • Federal payroll taxes (Social Security, Medicare, unemployment)
  • State employment taxes
  • Withholding and reporting employee income tax
  • Issuing W-2s to employees and 1099s to independent contractors

An LLC taxed as a corporation or S corp must treat active members drawing salaries as employees, which means proper payroll setup and withholding is essential. For LLCs treated as partnerships, members are typically not considered employees but may receive guaranteed payments, which are also subject to self-employment tax.

Understanding these nuances is crucial for compliance and proper tax planning.

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.

How to Change Your LLC Tax Classification

LLCs are not taxed directly by the IRS. Instead, they are treated as “pass-through” entities unless they elect a different classification. You may change the tax treatment of your LLC by filing specific forms:

  • To be taxed as a C corporation: File Form 8832 (“Entity Classification Election”) with the IRS.
  • To be taxed as an S corporation: File Form 2553 (“Election by a Small Business Corporation”) provided the LLC meets eligibility requirements.

Important considerations when electing a change:

  • You can only file Form 2553 for S corp status if the LLC meets specific criteria, such as having no more than 100 shareholders (members) and issuing only one class of membership interest.
  • Once you change your classification, you generally must wait 60 months before making another change, unless there's a qualifying event.
  • Changing your tax classification doesn't affect your LLC’s legal structure at the state level.

These elections can significantly impact how income is taxed and reported, so consultation with a tax advisor is strongly recommended. If you need assistance, you can find a qualified attorney through UpCounsel.

Frequently Asked Questions

  1. Can I change my LLC’s tax classification after forming it?
    Yes. You can file IRS Form 8832 or 2553 to change the default classification, but restrictions may apply regarding how often you can switch.
  2. What is the default tax status of an LLC?
    By default, single-member LLCs are taxed as sole proprietorships, and multi-member LLCs are taxed as partnerships.
  3. Is an S corp or C corp tax classification better for my LLC?
    It depends on your business goals. S corps avoid double taxation and reduce self-employment tax, while C corps offer retained earnings advantages and flexible ownership.
  4. What is a Series LLC, and should I form one?
    A Series LLC lets you create separate “cells” under one umbrella LLC, useful for real estate or multiple lines of business. Availability depends on your state laws.
  5. Do I need to file a tax return for my LLC if it has no income?
    Yes. Even if your LLC earns no income, you may still be required to file informational returns, especially if taxed as a corporation or partnership.

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