LLC Tax Treatment: Everything You Need to Know
Understanding LLC tax treatment requires a better understanding of a limited liability company and how it is recognized by the government. The first LLC earned IRS recognition in 1980, so this business entity is fairly new.3 min read
2. Reasons for Choosing an LLC
3. How to Form an LLC
4. Single-Owner LLC Taxation
5. Multiple-Owner LLC Taxation
What Is an LLC?
Understanding LLC tax treatment requires a better understanding of a limited liability company and how it is recognized by the government. The first LLC earned IRS recognition in 1980, so this business entity is fairly new. An LLC combines the benefits of a partnership or sole proprietorship, including the simplicity of forming and operating, with the liability protections available under a corporation. Since the IRS doesn't have specific tax classifications for this type of business entity, existing classifications for other types of businesses are applied to LLCs.
Reasons for Choosing an LLC
Members, also referred to as owners, of an LLC are only partly responsible for any business-related legal issues or unpaid debts. Your personal assets are not at risk; instead, business losses only extend as far as what you have invested in the LLC. Personal liability protection is similar under a corporation, but the drawback is that you will lose quite a bit of the flexibility in managing your business than you would have as a sole proprietor or member of a partnership.
By forming an LLC, you can take advantage of the personal liability protections without sacrificing business formation and operational flexibility. LLCs can have one member or an unlimited number of members. The member of an LLC can be corporations, individuals, or partnerships. Members of an LLC can choose to run the business themselves or hire someone else to handle the operational tasks.
How to Form an LLC
Similar to any other business entity, an LLC is always governed by the laws of the state in which it operates. In order to form an LLC, the first step is drafting the articles of organization. These articles should be filed with the office in the state in which the business will operate, along with the required filing fee. The articles of organization should be filed with the secretary of state's office or Department of Commerce.
If an LLC has more than a single member, all members should draft and agree upon an operating agreement. This document should outline:
- All LLC members' rights and responsibilities
- Percentage of ownership for each member
- Chosen tax treatment for the LLC
- Management structure
- Procedure for adding new LLC members
- Procedure to make decisions on major business issues
After establishing an LLC, you will likely need to pay any required state annual registration fees every year.
Single-Owner LLC Taxation
When an LLC has one member or owner, the business will be taxed in the same way a sole proprietorship is taxed. Similar to a sole proprietorship, the owner of the single-member LLC must file all tax information about the business on their personal tax returns. The business return is on Schedule C, while any losses and profits for the company will be outlined on the personal tax return of the owner. In addition to reporting all losses and profits, the LLC owner is responsible for paying all required Social Security, Medicare, and self-employment taxes on the business income.
An LLC's sole owner is legally required to report all losses and/or profits on tax Schedule C. You will then submit this with your personal tax return. It is required to pay taxes on any profits in the LLC's bank account at the end of the year, even if the funds will remain in the business for expansion or other purposes.
Multiple-Owner LLC Taxation
If an LLC has more than one owner, all owners must pay taxes in the same way they would if they were in a partnership. Unlike a single-member LLC, the members of a multiple-member LLC will not have to pay taxes on any income or profits from the business. Instead, these owners will pay taxes on their legal portion of any business profits through Schedule E, filed with their personal tax returns.
In order to file taxes properly on a partnership, all members must also include Form 1065, which outlines the total losses and profits that came from the LLC. Every member will also receive the Schedule K-1 tax form, which outlines the member's legal share of the profits and losses of the business.
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