LLC Taxed as Partnership: Everything You Need to Know
Having an LLC taxed as partnership is an appealing option for a business owner. As one of the newest types of business formations, the limited liability company, or LLC, is attractive for businesses of various sizes.3 min read
Having an LLC taxed as partnership is an appealing option for a business owner. As one of the newest types of business formations, the limited liability company, or LLC, is attractive for businesses of various sizes. One of the reasons it's so appealing is the flexibility it offers in registering the business and in how it is taxed. Limited liability company owner(s) can choose from several taxation options to reduce income taxes or save more business profits.
What Is an LLC?
An LLC is a legal business formation that all states recognize. When a business owner registers as an LLC, he or she can take advantage of limited personal liability while eliminating the double taxation that applies to corporations. Although states recognize LLCs, the IRS doesn't recognize this formation as a taxable entity.
Income taxation depends on two main factors:
- Whether the LLC is a single-member or multi-member entity.
- How the LLC elects for taxation.
Because LLC members are classified as self-employed business owners and not LLC employees, their earnings aren't subject to tax withholdings. Each member must set aside money throughout the year to pay taxes on their share of the business profits.
This process involves making quarterly estimates and paying those amounts to the IRS and any applicable state tax agency in:
Something that sets an LLC apart from a limited or general partnership is its limited personal liability. Unlike limited partners in a partnership, LLC members can participate in LLC management, as long as the laws and regulations within the state of operation allow for them to participate. State statutes outline the rules and regulations around an LLC's creation.
Limited liability companies must designate a tax entity classification with the IRS. Options include:
- Sole proprietorship
The classification depends on the LLC's number of members as well as how the business elects for taxation. This election will determine which federal tax laws apply to the business. To elect for taxation as a corporation, the LLC must file IRS form 8832, Entity Classification Election, and check the box to elect for corporation taxation.
How Single-Member LLCs Are Taxed
An LLC owned by a single member is classified as a business entity that is disregarded. By default, the IRS taxes a single-member LLC as a sole proprietorship. The owner must file Schedule C with his or her personal tax return each year. The information on Schedule C, including the business income, must carry over to the personal tax return form on line 12. For income tax purposes, a single-member LLC is a disregarded entity, meaning the business exists as a separate entity from its owner.
Because the single-member LLC is treated as a sole proprietorship, the business doesn't have to pay taxes at the corporate level or file a separate tax return. Any business profits left with the company at the end of the year, such as to grow the business or cover expenses in the future, must be reported. Taxes must be paid on this amount. Although the default classification is as a disregarded entity, a single-member LLC can also be taxed as a corporation.
To elect for taxation as a corporation, the LLC's single owner must file Form 8832 with the IRS and check the appropriate box. If the LLC owner doesn't file that form, the business is automatically classified as a disregarded entity and will be taxed as a sole proprietorship, based on federal tax guidelines.
How Multiple-Member LLCs Are Taxed
By default, an LLC with multiple members is taxed as a partnership. Any LLC that has more than one member will generally pay the required income taxes based on laws governing partnership taxation. The required tax document for partnerships is Form 1065. An LLC taxed as a partnership must provide a Schedule K-1 to each member, which will be included with their personal tax returns.
The business doesn't have to pay taxes directly. Instead, each business partner or member will report income and losses and pay income taxes based on their ownership share in the company. The Schedule K-1 outlines each partner's share of the business profits and losses.
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