LLC Taxes: Everything You Need to Know
LLC taxes are important to know how to do correctly when running a limited liability company. An LLC isn't a taxing entity in itself and doesn't get recognized by the Internal Revenue Services when it comes to taxes.3 min read
LLC taxes are important to know how to do correctly when running a limited liability company. An LLC isn't a taxing entity in itself and doesn't get recognized by the Internal Revenue Services when it comes to taxes. According to the IRS, an LLC can be taxed as a corporation or a partnership. They may also be disregarded from their owner in a separate entity. How taxes are paid in an LLC depends on if the LLC has a single member or multiple members, and if they choose to be treated differently for tax reasons.
Owners of a limited liability company have protection when forming one, and they also get taxed at their individual tax rates. While the LLC doesn't pay federal income taxes, some states have an annual tax that they need to pay.
How a Single-Member LLC Pays Income Taxes
LLCs that only have one member will be taxed as a sole proprietorship. That means any information about the LLC's expenses and income will be prepared with the Schedule C form. The net income from this form gets brought to line 12 of the owner's individual tax return. Single-member LLCs are considered disregarded entities for the purposes of income tax. The owner and the LLC are considered different entities, which is the regular designation for an LLC for one member.
If you have profits left over in the business' bank account by the end of the year, income tax must be paid on it. It doesn't matter what the money is for, whether it's to expand the company or cover any future expenses. This means the member is responsible for paying and filing all taxes.
How a Multiple-Member LLC Pays Income Taxes
An LLC that has multiple members pays income tax as a partnership. They don't pay taxes straight to the IRS, but rather each partner pays based on what percentage they owe in the partnership. An information return is filed with the IRS on Form 1065. A Schedule K-1 is then created for each partner that shows any profits and losses of the partnership. The K-1 is filed with each partner's personal return and the gain and loss will be shown on their Form 1040.
The profits and losses, known as a distributive share, need to be defined in the LLC operating agreement. The members' distributive shares are then divided up, and the IRS treats every LLC member as if they received their entire distributive share every year. Every LLC member needs to pay taxes on their whole distributive share, regardless of if the LLC distributes any or all of the money.
Income Tax for LLCs Classified as Corporations or S Corporations
An LLC can be an S corporation or a corporation for the purposes of taxes. This is done because it benefits the business of lower taxes for individuals who make a high income. The election is processed through Form 8832, which is the Entity Classification Election form. The LLC then pays their income tax, including state income tax, based on the new tax status. They will continue to act as an LLC and follow the operating agreement of the company. This new status will change how the LLC members are taxed as well.
If large amounts of profits will need to be kept in the LLC, known as retained earnings, it might be beneficial to choose corporate taxation. Any LLC can decide to be treated as a corporation for tax purposes and marking the corporate tax treatment tax on Form 8832. All C corporations are taxed on their profits at a 21 percent rate. The rate is lower than individual income tax rates, which range anywhere from 32 percent to 37 percent. Otherwise, this would be applied to LLC owners who have varying income levels.
Earnings that are retained aren't subject to double taxation. Choosing corporate taxation lets an LLC offer their employees and owners different fringe benefits that are tax-advantaged, stock ownership plans, and stock options. None of these are subject to double taxation. Once corporate election is chosen, the company can't switch to pass-through taxation for another five years without negative consequences.
If you need help with LLC taxes, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.