LLC Tax Rules: Everything You Need to Know
LLC tax rules differ depending on how many owners — or members — the business has. By default, the IRS taxes sole-owner LLCs as sole proprietorships and multi-member LLCs as partnerships. 3 min read
LLC tax rules differ depending on how many owners — or members — the business has. By default, the IRS taxes sole-owner LLCs as sole proprietorships and multi-member LLCs as partnerships. You may choose to be taxed like a corporation if you find it more beneficial. While most LLCs don't pay federal income taxes, they may be required to pay some state taxes.
Tax Filing Rules
If you choose to be taxed like a corporation, you'll file form 8832 with the IRS to make this election. When you elect corporate tax status, the business is treated as a separate tax entity. Therefore, the business has to report all income and deductions and pay any taxes by the deadline. If the LLC doesn't file a return or pay required taxes, its members aren't personally liable.
LLC owners may be able to reduce their tax burden by electing C corporation status, but they should keep in mind that money distributed from the business to its owners is subject to double taxation. They'll have to pay corporate taxes as well as taxes on any dividends they receive from the company. Each member reports dividends received as taxable income on their own form 1040.
- Stock options
- Stock ownership plans
These benefits aren't subject to double taxation.
LLCs that are taxed like partnerships don't pay taxes on business earnings, but they still prepare yearly tax returns on form 1065, which is only for informational purposes. Individual members report all credits, income, and deductions.
Sole proprietorships aren't considered separate legal entities from their owners, so owners are personally liable for all tax filings and payments. As a single-member LLC owner, you must complete a Schedule C when preparing your personal tax return. Schedule C reports the income and deductions related to business activities.
How Members Are Taxed
LLCs are considered "pass-through” entities, and all of the business's profits and losses pass through the company to the business owners. While the business pays no income tax at the federal level, it may have to pay annual taxes, depending on the state in which it's located.
For multi-member LLCs, each member has a share of company profits and losses, called the “distributive share.” This share should be outlined in the operating agreement. In most cases, distributive shares are in proportion to the percentage of interest that a member has in the business.
LLC members aren't considered employees, so they're not subject to tax withholding. Instead, they're viewed as self-employed business owners, and each member has to set aside enough money to pay taxes on his or her share of business profits. Members who must pay self-employment taxes report them on Schedule SE, which they submit along with their yearly tax return. They must also make estimated quarterly tax payments to the IRS (and possibly, a state tax agency for jurisdictions that have state income tax) four times a year.
In general, owners who work in or help manage the company are responsible for paying taxes on their distributive share. Owners who don't play an active role in the business — such as those who only invested money but don't make management decisions or provide services — usually don't have to pay these self-employment taxes.
You're not required to pay taxes on most of the money that goes back into your business. You can write off business expenses, which can lower the amount of profits you report.
In most states that tax LLCs, businesses pay taxes on profits the same way they do to the IRS: the business itself doesn't pay a state tax, but owners pay taxes to the state on individual returns. A handful of states do charge LLself-eCs taxes based on how much income the businesses make, in addition to the taxes the owners pay.
You have some flexibility in your tax status when you run an LLC. While tax savings are often the main factor in selecting a status, they shouldn't be the only factor. If you need help deciding which tax status is best for your business, you may want to consult with a tax professional.
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