1. Single-Member LLCs and Income Taxes
2. Multiple-Member LLCs and Income Taxes
3. Corporations and Income Taxes

LLC tax rate is one important consideration when choosing a business entity. Every state in the U.S. recognizes a limited liability company (LLC) as a form of business organization. Business owners who pay income taxes at a personal tax rate may form an LLC to obtain limited liability protection.

The most important reason business owners form an LLC is to protect their personal assets, separating them from the business. That way, if there is a lawsuit, or unpaid debts, owners' personal assets cannot be seized by banks or bill collectors. However, taxes are what most small business owners have in mind when they consider forming an LLC.

Small business owners often consider different structures for their businesses to avoid paying self-employment taxes, or eliminate “double taxation” when tax time rolls around. Unlike a corporation, a limited liability company (LLC) is called a “pass-through entity” by the IRS; this works in a similar way to a partnership or sole proprietorship. 

Depending on the choices made by the owners, or members, the LLC is permitted by the IRS to be taxed as either a sole proprietorship, a corporation, or a partnership.

Single-Member LLCs and Income Taxes

For tax purposes, one-member LLCs are treated the same way the IRS treats sole proprietorships. The LLC does not have to file a return on its own behalf, and does not pay its own taxes.

  • If you are an LLC's sole owner, you will pay self-employment tax on your profit.
  • Profits and losses are reported on the Schedule SE form.
  • Your business income will be reported on Schedule C.
  • All profits and losses that the LLC incurs must be reported on the sole owner's personal 1040 tax return using Schedule C.
  • You must pay taxes on all profits, even if they are left in the company's bank account to cover operating expenses.

Multiple-Member LLCs and Income Taxes

When an LLC has more than one member, or owner, it is treated like a partnership for income tax purposes. This includes co-owned LLCs, which are treated as partnerships for tax filing. As with single-member LLCs, co-owned LLCs do not file their own taxes.

  • LLC owners must pay income taxes on their own share of the business profits, reporting this income on their 1040 tax returns using Schedule E.
  • A distributive share will be specified in the LLC operating agreement; this is the share of profits and losses that belongs to each LLC member.
  • A co-owned LLC must file Form 1065 with the IRS, even though it does not pay taxes on its own behalf.
  • Form 1065, which is also filed by partnerships, is used by the IRS for information purposes. It is reviewed in order to check accuracy of each LLC members' tax returns.
  • Each member's share of the LLC's profits and losses must also be reported with a Schedule K-1 form.
  • This profit and loss information will be reported by each LLC member's personal 1040 tax form, and they must attach Schedule E.

Members' distributive shares are figured in proportion to the percentage of the business they own. A “special allocation” may be used, following IRS rules, to split up the profits and losses in a different manner that is not proportionate to the percentage of ownership for each member.

No matter which allocation method is used, the IRS requires each member to claim their entire distributive share at the end of the year.

Even if the money is not actually distributed to the owners and remains in the business's bank account, each member must still pay taxes on their share. This means that if the LLC members leave their profits in the business's coffers to provide operating capital, they are still responsible for paying taxes on it.

Corporations and Income Taxes

Along with sole proprietorships and partnerships, LLCs may also choose to be treated as corporations for the purpose of tax filing.

  • This requires form 8832 to be filed with the IRS.
  • The LLC also files the Form 1120 tax return.
  • Profits from an LLC that is treated as a corporation are not subject to self-employment tax.
  • If the owners receive dividends, however, they are taxed at the qualifying dividend rate of 15 percent.
  • A corporation must also pay taxes on LLC members' wages, if they are working in the business.

The decision about your LLC's tax entity requires serious consideration and depends upon your business's unique needs. You'll need to take time to investigate changing tax rules for both federal and state returns.

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