Tax Obligations for LLC: Everything You Need to Know
Understanding tax obligations for LLC is essential for new business owners. An LLC protects its owners from being liable for company-related debts and lawsuits.3 min read updated on January 01, 2024
Understanding tax obligations for LLC businesses is essential for any new entrepreneur. A limited liability company is a type of business which protects its owners, who are called members, from being liable for company-related debts and lawsuits. Whether you are interested in forming an LLC for liability protection or you've already established your business, it's smart to understand the tax benefits of having an LLC.
LLC Tax Basics
Familiarizing yourself with your tax obligations as an LLC member can help you avoid being audited. Tax filing requirements for an LLC depend on how its members choose to be taxed. For instance, the IRS disregards LLCs as tax entities by default, but you may elect to be taxed as a partnership or corporation instead.
First of all, remember that LLCs are sanctioned via state laws, not the Internal Revenue Service. Since state laws vary, you may have a choice in how your LLC is taxed. If you want to choose to be taxed as a corporation, you should file IRS Form 8832.
Single-Member vs. Multi-Member LLCs
LLCs are “pass-through” entities, where the business profits and losses pass onto the owners, who then report the information on their tax returns. As such, LLCs are similar to sole proprietorships or partnerships depending on how many members there are.
An LLC doesn't pay federal income taxes itself like a corporation would, although certain states do have annual tax requirements. In some cases, you can elect to be taxed as a corporation.
If you are the sole member, you alone are taxed as a sole proprietor. In a multi-member LLC where there are multiple owners, each member must report their income and expenses on their personal tax return. How your business divides profits and expenses should have already been outlined in your LLC's operating agreement.
For example, if you are the founder of the LLC and you own 60 percent of the company, and your business partner owns the other 40 percent, you are each entitled to your specific percentage of the shares and losses in the business. You may select a special allocation situation where you split profits and losses in a way that's not proportionate to how much each of you owns.
It's important to note that the IRS assesses taxes on your whole distributive share, meaning that you are taxed based on your yearly share of the LLC even if you don't actually obtain all that money. The IRS does this for one practical reason: even if you reinvest some of your profits back into the business, such as purchasing inventory, you still owe income tax on your rightful share.
You probably already know that LLC members do not have taxes automatically withheld from their paychecks. Because of this fact, you may need to make quarterly estimated payments to the IRS.
In addition, you are responsible for paying all taxes owed at the state level. Be sure to stay updated on your state's tax guidelines to avoid costly penalties.
Opting to Be Taxed as a Corporation
In some situations, you may opt to have your LLC taxed like a corporation. When this occurs, you will face double taxation similar to a C corporation tax structure. Still, despite paying taxes twice, you may find yourself saving money overall.
To choose the corporate tax option, file Form 8832 with the IRS. Starting in the 2018 tax year, all C corporations are taxed at a flat 21 percent rate. After the flat tax rate, you also then pay individual income tax, which can increase your tax rate to 23.8 percent.
Being taxed as a corporation affords multiple benefits:
- Retained earnings are not taxed twice.
- LLC owners and employees have access to stock options and ownership plans.
- The corporate tax rate is lower than any of the leading individual income tax rates, which range from 32 to 37 percent.
Since LLC members are not employees, no Social Security or Medicare is withheld from their incomes. Instead, you must pay these taxes as self-employment taxes. Whether you are a single-member LLC, a multi-member LLC, or corporation, you can pay self-employment taxes by filing Schedule SE Form 1040. You must pay this tax even if you reinvest some of your profits back into the company.
Typically, LLC members pay twice as much money in self-employment tax as standard employees because employee contributions are employer-matched.
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