Key Takeaways

  • The taxes an LLC pays depend on its classification — single-member, multi-member, or corporate election.
  • By default, LLCs are pass-through entities: profits “pass through” to owners’ personal tax returns.
  • LLC members are responsible for self-employment taxes, including Social Security and Medicare.
  • Electing to be taxed as an S corporation or C corporation can lower overall tax liability in some cases.
  • LLCs may owe state income, franchise, or sales taxes, depending on where they operate.
  • Deductions for ordinary and necessary business expenses can reduce taxable income.

LLC taxation IRS differs, depending on how many owners — or members — the company has. By default, LLCs are taxed as partnerships or sole proprietorships when they're created. However, business owners may choose other classifications (as long as they're eligible) if they find them more beneficial. 

Income Taxes for Single Owner LLCs

Single-member LLCs are considered disregarded entities, meaning that the business and the owner are legally separate entities. For tax purposes, the IRS treats single-member LLCs as sole proprietorships. The business itself isn't responsible for federal taxes, so it doesn't file a tax return with the IRS.

If you're the sole owner of an LLC, you'll report all of your business profits and losses on Schedule C and include it with your 1040 return. You'll file a return as a sole proprietor.

If you choose to leave profits in the LLC bank account at the end of the year, you're still required to pay income tax on them. You might choose to leave profits for the following reasons:

  • To expand the company
  • To cover future expenses

Self-Employment Taxes for LLC Owners

Even though a single-member LLC is a disregarded entity for federal income tax purposes, its owner is still responsible for self-employment taxes on the business’s net income. These taxes cover Social Security and Medicare contributions, amounting to 15.3% of net earnings. This is in addition to regular income tax reported on Schedule C.

To calculate self-employment tax, the IRS requires single-member LLC owners to complete Schedule SE (Form 1040). However, owners can deduct the employer-equivalent portion of these taxes (50%) when computing their adjusted gross income, helping to lower the overall tax burden.

LLC owners may also consider making quarterly estimated tax payments to avoid IRS penalties. These payments cover income and self-employment taxes that would otherwise be withheld if the owner were an employee.

Income Taxes for Multiple Owner LLCs

For tax purposes, the IRS treats multi-member LLCs as partnerships. As with single-member LLCs, multi-member LLCs aren't taxed themselves. Instead, the LLC's members file individual tax returns where they pay taxes according to their share of the company's profits.

In an LLC's operating agreement, the distributive share — the share that each member holds in profits and losses — should be clearly defined. In most cases, distributive shares are in proportion to how much interest a member has in the company. If you choose to divide profits and losses in another way — that is, not in proportion to members' percentage interests — it's a special allocation.

Although an LLC doesn't pay income taxes as a business, it still files form 1065. This is an information return, and the IRS reviews it to ensure that all members in an LLC are giving accurate accounts of their income. Form 1065 is strictly for informational purposes. Individual owners use it to report all credits, income, and deductions.

LLCs also give each member a Schedule K-1, which details each member's share of business profits and losses, and members submit their Schedule K-1 with form 1065.

There's a specific rule for LLC members who don't actively participate in the business (the equivalent of limited partners): they only pay taxes on compensation received from the LLC for services provided, so they're not responsible for paying self-employment taxes on the business profits that they receive.

State and Local Taxes for LLCs

Beyond federal taxes, LLCs are often subject to state and local tax obligations, which vary by jurisdiction. Common examples include:

  • State Income Taxes: Many states mirror the IRS pass-through structure, taxing members individually on their share of profits. Some states, however, also impose entity-level taxes on LLCs.
  • Franchise Taxes: Certain states, like Texas and California, require LLCs to pay annual franchise or margin taxes based on revenue or net income.
  • Sales and Use Taxes: LLCs that sell taxable goods or services must register for a state sales tax permit and collect applicable taxes from customers.
  • Employment Taxes: If an LLC hires employees, it must withhold and remit federal and state payroll taxes, including unemployment and disability insurance contributions.

Understanding your state’s specific tax rules is crucial, as filing and payment schedules differ. LLC owners may need to register with their state’s Department of Revenue or equivalent agency.

Should You Be Taxed as a Corporation?

In most cases, business owners choose the tax form that benefits them the most financially.

At the high end of the tax table, the tax rate for partnerships and sole proprietorships is more than the highest corporate tax rate. If you fall in this high tax bracket, as a sole entrepreneur or partner, you might decide to separate your personal taxes from your business.

The main benefit of being an LLC that's taxed as a corporation is not being required to take all business income on your own return. For instance, say your business has a net profit of $50,000 at the end of the year. If you're the sole owner, you take all of the profit on your individual tax return. If you choose to have your business taxed as a corporation, however, you can keep some or all of the profit (keeping it in the business), so you don't have to pay personal income tax on it.

One disadvantage for being taxed as a corporation is being subject to double taxation. You'll pay taxes on the business income as well as income you receive as dividends. You'll have to carefully weigh the savings of electing corporate status. Otherwise, it may not be worth it if double taxation winds up costing you more than you save.

Because taxes can be a complex area, many business owners find it beneficial to hire tax experts, such as CPAs and financial advisers. You may want to consult with them before choosing another tax status to ensure you're making the smartest move for your business.

Electing S Corporation or C Corporation Taxation

LLC owners can choose to be taxed as an S corporation or C corporation by filing Form 2553 or Form 8832 with the IRS. This flexibility allows members to optimize tax outcomes:

  • S Corporation Election: Profits and losses still pass through to owners, avoiding corporate-level tax. However, owners can pay themselves a reasonable salary subject to payroll taxes, while additional profits may be distributed as dividends, reducing self-employment tax exposure.
  • C Corporation Election: The business becomes a separate tax-paying entity subject to the 21% federal corporate tax rate. Although double taxation applies (on corporate income and shareholder dividends), this structure may be advantageous for reinvestment-heavy businesses or those seeking outside investors.

The choice between S and C corporation taxation should consider income level, profit retention, and long-term growth goals. Consulting a tax professional can help identify the most tax-efficient structure for your LLC.

How to Reduce LLC Taxes Legally

LLC owners can minimize their tax burden through legitimate deductions and strategic planning:

  • Deduct Business Expenses: Costs such as rent, utilities, insurance, travel, marketing, and professional services are deductible.
  • Take Advantage of the Qualified Business Income (QBI) Deduction: Under the Tax Cuts and Jobs Act, eligible LLC members can deduct up to 20% of qualified business income, reducing their taxable income.
  • Track Depreciation: Deducting depreciation for business assets like vehicles and equipment lowers taxable income.
  • Hire Family Members: Employing family members in the business can shift income into lower tax brackets.
  • Consider Health Insurance and Retirement Plans: Contributions to health insurance premiums and retirement plans (like a SEP IRA) can be deductible business expenses.

Maintaining meticulous financial records and separating business from personal accounts are vital for maximizing deductions and avoiding IRS scrutiny.

Frequently Asked Questions

1. What taxes does an LLC pay to the IRS?

An LLC pays federal income tax through its owners’ personal tax returns unless it elects corporate taxation. Members are also responsible for self-employment taxes on their share of business income.

2. Do LLCs pay state taxes?

Yes. Many states impose income or franchise taxes on LLCs. Some may also require annual filing fees or business privilege taxes.

3. How can LLC owners reduce their taxes?

Owners can claim deductions for business expenses, utilize the QBI deduction, and structure compensation to minimize self-employment tax.

4. What is the difference between an LLC taxed as an S corp and a C corp?

An S corp allows profits to pass through to owners while minimizing self-employment taxes, whereas a C corp pays its own corporate tax but may face double taxation on dividends.

5. When should an LLC elect to be taxed as a corporation?

When profits are high or the business plans to reinvest earnings, electing corporate taxation may yield a lower overall tax rate. Always consult a tax professional before making this change.

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