An LLC taxed as a partnership is an option for business owners who want their company to be taxed as a partnership but receive the benefits of a limited liability company (LLC). By default, the IRS treats all LLCs with one member as sole proprietorships for tax reasons. This means the business doesn't have to pay taxes on losses and gains. It also doesn't have to file a separate tax return with the IRS.

Single-Owner LLC Taxes

The sole owner of an LLC is responsible for reporting all business losses and profits on Schedule C and filing it with his or her personal 1040 tax return form. Even if the business retains some of its profits at the end of the year, such as to grow the business or cover future expenses, the owner must pay income taxes on all remaining funds.

Multi-Owner LLC Taxes 

The IRS treats LLCs with more than one owner as partnerships. Similar to single-owner LLCs, multi-owner LLCs do not have to pay taxes on profits or losses. The business owners must report their profit shares on their personal tax returns and pay required taxes on those amounts. Multi-member LLC members report their profits and losses on Schedule E.

An LLC's operating agreement should clearly outline every member's share of the business losses and profits. This share is referred to as a distributive share. Operating agreements often state that a member's distributive share is directly proportional to his or her percentage of interest in the LLC. If members choose to distribute losses and profits in a manner that isn't proportional to membership and business interests, this is referred to as a special allocation.

Regardless of how the LLC divides shares of profits and losses among its members, the IRS will still treat each member as if he or she received the entire distributive share during the previous year. As a result, the LLC members are required to pay the full amount of taxes on the entire distributive share at tax time every year, even if the business didn't distribute profits to its members. 

Although multi-owner LLCs don't have to pay income taxes, these businesses are required to file IRS Form 1065 each year. Form 1065 is also filed by partnerships and includes information that the IRS can review to make sure the LLC's members reported all income correctly. Limited liability companies are also required to provide all members with a Schedule K-1. This document includes a breakdown of each member's share of the business losses and profits. 

Members will then report the information outlined on the Schedule K-1 on their own personal tax form 1040 and attach Schedule E, another required form.

Consider Electing Corporate Taxation

When a business needs to keep a large portion of its profits within the company, referred to as retained earnings, it might make sense to elect for taxation as a corporation. Limited liability companies can elect for taxation as corporations by filing Form 8832 with the IRS, which is the Entity Classification Election. On this form, simply check the corporate tax treatment box to elect for corporation taxation.

After filing this form, the next step is deciding how to be taxed, with two options:

To elect taxation, the LLC owner(s) must file an election form with the IRS. After filing the required forms, the IRS will treat the LLC as if it was a corporation. The business must then file all tax forms required of corporations.

Estimating and Paying Income Taxes

Limited liability company members are considered to be self-employed owners of businesses, not LLC employees. Therefore, they aren't subject to tax withholdings. All LLC members must do the following: 

  • Set aside enough money throughout the year to pay taxes on their shares.
  • Because the members don't necessarily know how much they will receive at the end of the year, they must make estimates each quarter and make payments to the IRS. 
  • If state income tax applies, the members must also make quarterly payments to the proper state agency. These payments must be made every year in April, June, September, and January.

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