LLC for Tax Purposes: Everything You Need to Know
An LLC for tax purposes is formed when a business wants to take advantage of the tax benefits offered when operating an LLC.3 min read
An LLC for tax purposes is formed when a business wants to take advantage of the tax benefits offered when operating an LLC. Since the LLC is not a separate entity from its owners (members), the members must report the profits and losses from the LLC on their own personal income tax returns. With regard to federal tax treatment, there is greater flexibility in that an LLC can elect to be taxed in the following ways:
- Sole proprietorship for a single-member LLC
- Partnership for a multi-member LLC
- S or C corporation for a single or multi-member LLC
Income Taxes for Your LLC
If you don’t elect to be taxed, then the Internal Revenue Service (IRS) will tax your LLC as a sole proprietorship (single-member LLC) or a partnership (multi-member LLC). You will also need to pay self-employment taxes if you’re engaged in active trade, i.e. providing services or selling products. However, if your LLC was formed as a passive entity, i.e. real estate investment, then you will not be required to pay self-employment taxes on the LLC’s profits.
Single-Member vs. Multi-Member Taxation
If you are taxed as a sole proprietorship, then you as the single owner will report all of the profits of the LLC on your personal tax return. Such taxes will be reported on Schedule C along with your 1040 tax return.
Multi-member LLCs will report the LLC profits on Form 1040, along with Schedule E. In order to identify the distributive share that each member will need to report, you will look to the LLC’s operating agreement, which should specify how much each member is responsible for. Some operating agreements might provide that each member has an equal distributive share, meaning that all members will report an equal amount of profits from the LLC.
For example, if there are four members in an LLC, then all four members will pay 25% of the LLC profits. However, other LLCs might choose to distribute the “shares” in the LLC based on how much money each member contributed at the time of formation. Therefore, if two of the four members contributed 20% each, and the other two members contributed 30% each, then the first two members will each report 20% of the LLC’s profits on their personal tax return, whereas the second two members will each report 30% of the LLC’s profits on their personal tax return.
For a single-member or multi-member LLC, you can choose to be taxed as either an S Corp or C Corp. If you choose to be taxed in this manner, then you will need to file IRS Form 8832, Entity Classification Election. The main reason that LLCs choose to be taxed as a corporation is due to the potential tax savings, especially if you want to retain a significant amount of earnings as opposed to spending them or distributing them to the other members.
Therefore, while your LLC continues operating as an LLC, the LLC will in fact be taxed as a corporation. Before choosing to be taxed in this manner, you should weigh the pros and cons. While there could be potential tax savings for your LLC, keep in mind that C corporations are double-taxed at the corporate level and again at the personal level. This means that all profits of the LLC are taxed (at a rate of 21%). If any of the taxed profits are distributed to the owners of the LLC, those distributions are taxed again (at an individual tax rate depending on the member’s specific personal income).
In addition to the choice of electing to be taxed as a C corp, you can also elect to be taxed as an S corp. The S corp doesn’t face double taxation. If you do choose to be taxed in this manner, then you will need to file a 1120S tax return. The LLC members will file these taxes, similar to that of a sole proprietorship. Furthermore, the members will not be required to pay self-employment tax.
If you need help filing taxes for your LLC, or if you need assistance determining how your LLC should be taxed, 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.