US LLC Tax Treatment: Everything You Need to Know
US LLC tax treatment is one of the main reasons many business owners choose to form limited liability companies.3 min read
US LLC tax treatment is one of the main reasons many business owners choose to form limited liability companies. When it comes to taxes, the IRS does not consider LLCs to be separate entities but, rather, pass-through entities. In a pass-through tax entity, all the profits and losses pass through the business to the owners on their personal tax returns. While an LLC does not pay federal taxes, it might be taxed at the state level.
The IRS treats LLCs as either sole proprietorships or partnerships, depending on the number of owners that make up the LLC. The differences between these two tax treatments are:
- SIngle-owner LLC - If your LLC has just one member, it will be treated as a sole proprietorship. This means your business does not need to pay taxes or file a business return with the IRS. To pay taxes on the company, you must fill out a schedule C with your 1040 tax return. This is where you report profits. If you have money left over to be put into the company during the next year, it will still be taxed as if you had received it as profit.
- Multi-owner LLC - If your LLC has more than one member, it will receive the same tax treatment as a partnership. Similar to a single-owner LLC, you will not pay taxes at the business level. Instead, each owner's portion of the profits will pass through to their personal tax returns. They will use a schedule E to report their portion of the profit and losses.
Each member of a co-owned LLC will receive a distributive share, which is their portion of their percentage of the business profits. For example, if one owner owns 40 percent of the company and another owns 60 percent, the first owner would claim 40 percent of both the profits and losses on their personal 1040 tax return and the other would be responsible for 60 percent. Because this type of split is not proportional between the members, it is referred to as a "special allocation." It is important to note that even if a member does not receive their portion of the profits or puts them back into the company, they will still be required to pay taxes on it. These earnings, however, are not subject to double taxation.
Unlike a single-member LLC, a co-owned one must file an information tax return, Form 1065, with the IRS. This will serve as a guideline the IRS can use to compare each owner's share of the profits and losses to their personal tax returns. Businesses must provide each member with a Schedule K-1, which breaks down each owner's share of the profits and losses and lets them know what they need to report on their personal tax returns.
If your company begins to make a significant profit, it might be in the owners' best interests to elect their LLC to be taxed as a corporation. This can help the owners save money when it comes to filing taxes. To elect to be treated by the IRS as a corporation, you will need to file Form 8832 and select the corporate tax treatment box. As of 2018, the flat tax rate for C corporation is 21 percent on all profits. This can be a good option if owners fall into one of the top three income tax brackets, which can range from 32 percent to 37 percent in taxes.
Make sure the tax benefits of electing to be taxed as a corporation weigh in your favor. The corporation must pay the corporate tax and the owners must pay taxes on their personal returns on dividends at the capital gains rate of 23.8 percent.
Some owners might choose the corporation election to gain corporate tax-advantaged benefits, including:
- Stock options.
- Stock ownership plans.
- Retirement plans.
None of these are subject to double taxation.
Another benefit of opting for corporate tax treatment is that the corporate rates on the first $75,000 of taxable income are lower than individual income tax rates. This can be a money-savings for all the LLC's members.
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