LLC Tax Structure: Everything You Need to Know
The LLC tax structure is similar to the structure of other types of business entities. An LLC is different from a corporation, such as an S-corp or C-corp, because it isn't a taxable entity that is separate from the owner.3 min read
2. LLC Tax Requirements
3. Tax Possibilities for Your LLC
How Do LLCs Get Taxed?
The LLC tax structure is similar to the structure of other types of business entities. An LLC is different from a corporation, such as an S-corp or C-corp, because it isn't a taxable entity that is separate from the owner. Instead, an LLC is called a pass-through entity by the IRS. This phrase means that any tax requirements and liabilities will pass through the business to the owner(s) on their personal income tax returns.
One of the benefits of setting up your business as an LLC is the flexibility that comes with deciding the tax structure. You can choose among taxation that is similar to a corporation, sole proprietorship, or partnership, as long as you file the correct IRS forms. By default, the IRS will classify an LLC as a:
- sole proprietorship if the business has one member (or owner)
- partnership if the business has more than one member
For a single-member LLC, the IRS automatically applies the tax rules for sole proprietorships.
Multimember LLCs are automatically taxed as partnerships. An LLC needs an operating agreement in place to outline how the business will be run. Although many states do not list the operating agreement as a requirement for establishing an LLC, it is always smart to have one. An operating agreement is basically a contract between all LLC members. It will outline the business structure, including which tax structure will be applied. Check with your secretary of state's office to find out if the operating agreement is required as part of the filing process.
LLC Tax Requirements
One requirement on a federal level is filing form 1065 with the IRS. This form is used to make sure every LLC member is reporting their business income properly. Additionally, each member should receive the Schedule K-1, which outlines the business profits and losses.
An LLC might choose a tax structure that is similar to a corporation, such as an S-corp or C-corp. This option allows the owners to keep more of the profits within the business. Additionally, any retained earnings will have lower tax rates, in most cases, than the earnings would be taxed on a personal return. In order to choose this LLC taxation model, you must file IRS Form 8832, Entity Classification Election. On this form, complete the section that discusses LLC taxation as a corporation.
In order to elect S-corp taxation, you must also complete the Election by a Small Business Corporation form, which is IRS Form 2553. The members of an LLC are not considered employees, so it's important to save some of the business profits for when you file your personal tax return. However, you cannot hold Medicare or Social Security taxes on each paycheck.
Laws regulating LLCs vary among states, so your state could apply different taxation rules. It's smart for an LLC owner to consult with a business accountant or attorney to understand the laws in the state.
Tax Possibilities for Your LLC
Many startup company owners are using the LLC business structure to take advantage of the benefits. By forming an LLC, a business owner has the personal liability protection of a corporation but doesn't have to go through the extensive formalities, paperwork, and red tape of actually forming a corporation. For solo entrepreneurs, startup owners, and small-business owners, an extensive business formation process can be a burden.
Upon deciding to legally form your business as an LLC, you may be surprised to find out that you also have to decide on a taxation structure. It's important to consider the benefits of all taxation structures for your business, especially when you consider that taxes are probably a big part of what pushed you toward setting up your company as an LLC. Since an LLC exists under state regulations and statutes, not federal standards, it comes with more federal tax flexibility.
An LLC with one member will typically be taxed in the same way as a sole proprietorship, assuming you are the only owner of the business. The sole proprietorship taxation structure is a pass-through category, which means you don't have to file separate tax forms for the business.
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