Key Takeaways

  • LLCs are pass-through entities by default, meaning profits and losses pass through to owners’ personal tax returns.
  • Single-member LLCs are taxed like sole proprietorships; multi-member LLCs are taxed like partnerships unless an election is made.
  • LLCs can elect to be taxed as a C corporation or S corporation for strategic tax planning.
  • S corp election can reduce self-employment taxes but requires payroll compliance and IRS Form 2553.
  • C corp election may offer lower corporate tax rates on retained earnings but can lead to double taxation.
  • State tax obligations vary, and LLCs may be subject to franchise, gross receipts, or other state-level taxes.
  • Strategic planning can help reduce taxable income through deductions, credits, and reinvestment.

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.

Understanding Default and Elective Tax Classifications

By default, the IRS classifies LLCs as disregarded entities (sole proprietorships) or partnerships based on the number of members. However, LLCs may elect to be taxed as corporations by filing Form 8832. From there, an additional election may be made to be taxed as an S corporation by filing Form 2553, as long as eligibility criteria are met.

Here’s a quick comparison of LLC tax classification options:

  • Sole Proprietorship (Single-Member LLC): Income reported on Schedule C of the owner's Form 1040. Subject to self-employment taxes.
  • Partnership (Multi-Member LLC): Income split among members using Schedule K-1 and reported on Form 1065. Members pay self-employment taxes.
  • S Corporation (S Corp Election): Must file Form 2553. Members receive salaries (subject to payroll taxes) and profits (subject only to income tax). Reduces self-employment taxes.
  • C Corporation (C Corp Election): Must file Form 8832. The LLC becomes a separate tax-paying entity. Subject to double taxation (corporate and personal dividends).

Each option has advantages based on income level, profit retention strategy, and administrative capacity​​.

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.

Federal Filing Responsibilities for LLCs

LLCs must comply with IRS filing obligations based on their tax classification:

  • Single-Member LLCs: File Schedule C, E, or F with the owner's personal return (Form 1040).
  • Partnership-Style LLCs: File Form 1065 and provide each member a Schedule K-1.
  • S Corporations: File Form 1120-S. Owners receive a Schedule K-1 for their share of business income.
  • C Corporations: File Form 1120 and pay corporate taxes directly.

LLCs taxed as corporations must also comply with estimated tax payments, employee payroll tax filings, and corporate recordkeeping requirements.

Additionally, all LLCs should obtain an EIN from the IRS, even single-member LLCs, to open bank accounts and handle payroll.

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.

State and Local Tax Considerations for LLCs

While LLCs enjoy federal flexibility, they may face specific state tax obligations. Depending on the state, these may include:

  • Franchise Taxes: Annual fees or taxes based on net worth or gross receipts (e.g., California, Tennessee).
  • Gross Receipts Taxes: Applied to revenue, not profits, in states like Nevada or Ohio.
  • Annual Reports: Most states require LLCs to file an annual or biennial report and pay a filing fee.
  • Sales Tax: Required for LLCs that sell taxable goods or services.
  • Employment Taxes: Must be paid if the LLC has employees, including state unemployment insurance.

Always consult your Secretary of State or Department of Revenue for specific requirements. Legal or accounting professionals can also help you remain compliant across jurisdictions.

Strategies to Minimize LLC Taxes

LLCs can reduce their overall tax burden by utilizing these common strategies:

  • Elect S Corporation Status: To minimize self-employment taxes on profits beyond reasonable compensation.
  • Maximize Deductions: Deduct business expenses like equipment, mileage, travel, marketing, and home office use.
  • Retirement Contributions: Set up a SEP IRA or Solo 401(k) to defer taxes while saving for retirement.
  • Health Reimbursement Arrangements (HRAs): Can be used to reimburse members for out-of-pocket medical expenses.
  • Depreciation and Section 179: Write off the cost of business assets faster to reduce taxable income.

These strategies should be tailored to the LLC’s size, revenue, and owner goals. A qualified accountant or tax professional can help ensure compliance while maximizing deductions​​.

Frequently Asked Questions

  • Can an LLC avoid paying self-employment taxes?
    Yes, if an LLC elects S corporation taxation, owners can receive a reasonable salary (subject to payroll taxes) and take additional profits as distributions, which are not subject to self-employment tax.
  • How do I change my LLC’s tax classification?
    You must file IRS Form 8832 to elect taxation as a corporation, and IRS Form 2553 if you also want to be treated as an S corporation.
  • What happens if I don’t make a tax election for my LLC?
    The IRS will default your LLC to a sole proprietorship (for single-member LLCs) or a partnership (for multi-member LLCs).
  • Are LLCs subject to double taxation like C corporations?
    Only if the LLC elects to be taxed as a C corporation. Otherwise, LLCs are pass-through entities and avoid double taxation.

  • Does every LLC need to file Form 1065?Only multi-member LLCs taxed as partnerships must file Form 1065. Single-member LLCs and LLCs taxed as corporations file different returns based on classification.

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