As a small business owner, it is vital to know where your money is going and what taxes you must pay every month, quarter, or year, so you can budget accordingly. A limited liability company (LLC) is a business that gives the owners limited liability, so their assets are protected if they were to be sued or get into financial difficulty. For this reason, it’s an incredibly popular business structure, but understanding how they are taxed can be complicated. We’ve broken it down for you here, so read on to understand exactly how LLCs are taxed so you can move forward with confidence.
A limited liability company (LLC) is what the IRS refers to as a "pass-through entity." This means that it’s not a separate tax entity, and the LLC will not have to pay taxes on business income – just the owners on their income. Some states do apply additional charges or taxes, so make sure you research what is required of LLCs in your state.
Alternatively, you can elect for your LLC to be taxed as a corporation, instead of as a pass-through entity.
The IRS views single-member LLCs as a “disregarded entity”, which means that it’s not required to file a separate income tax return from the owner. Essentially, you continue to operate as a sole proprietor but have the legal protections of an LLC. You will report your earnings and expenses on Form 1040, Schedule C.
It’s also worth noting that, as a single-owner LLC, you must pay income tax on any money in the business account. This is applicable even if you leave it in the company's bank account at the end of the year for future expenses or to expand your company.
If your LLC generates a profit at the end of the year after deducting business expenses, you’ll owe taxes to the IRS in accordance with your personal income tax rate. If you make a loss for the year, you can deduct the business’s losses from your personal income.
As we touched on at the beginning, multi-member LLCs (two people or more) are taxed as a “pass-through entity” unless you choose corporate tax status, which will discuss a little later.
Like single-member LLCs, multi-member pass-through entities do not pay income tax in their own right – each member pays taxes on the LLC’s income in proportion to their ownership.
For example, if two members own 50% each, and the business makes $100,000 in income, they would each be taxed for $50,000 on behalf of the business. They could each also claim 50% of the tax deductions and credits their LLC is eligible for, and write off 50% of the losses. (This works very similarly to a partnership, so can be a natural next step for partnerships looking to upgrade to an LLC.)
Any multi-member LLC must file Form 1065 (U.S. Return of Partnership Income), and each member must complete a Schedule K-1, which essentially gives the IRS the complete picture of the business.
If you elect to have your LLC taxed as a corporation, things can get a little more complicated, so it’s worth consulting an accountant if you decide to go this route. The members of an LLC can vote to make this change, which must be reflected in the LLC operating agreement.
You can opt to be taxed as either a C-Corp or an S-Corp. If you aren’t sure what the difference is, here’s what you need to know:
C-Corporations: LLCs taxed as C-Corps are taxed at 21% (with Form 1120), and are quite uncommon, but one of the advantages of this setup is what is called “income splitting.” This occurs when a business makes enough money to justify the owner taking home a sizable salary, but not so much money that the company’s profits are eliminated.
This is helpful to business owners as it allows them to remain in a lower tax bracket, but this is only advisable if the owner works closely with a reputable accountant. Otherwise, they may be subject to Accumulated Earnings Tax, which occurs when a company keeps its profits within the company for too long.
While there are clear advantages to being taxed as a C-Corporation, there are some notable disadvantages, such as double taxation. As the name suggests, it occurs when the business owner is taxed corporately and on a personal level.
S-Corporations: Here, the company owner pays self-employment taxes on all the company’s profits. This comes in at 15.3% of the company’s net income. Although the company’s owner pays self-employment taxes on the company’s profits, they must also technically become an employee of the company and as such must elect a reasonable salary from these funds. They must pay the 15.3% self-employment tax on this salary, but the leftover funds are not subject to the same tax. This sounds like a lot of money saved, but the LLC owner will likely also incur additional expenses like payroll taxes, an accountant’s salary, and administrative fees for payroll processing.
LLC members are considered self-employed business owners so they aren’t subject to tax with holding. Each LLC member must make sure they put aside enough money to pay taxes on their share of the profits (15.3% of their income). Each LLC member must preempt the approximate amount of tax they will owe for the year and make appropriate payments to the IRS each quarter.
Yes – if you sell taxable services or products, you’ll need to collect sales tax on your customers’ behalf. What qualifies as taxable services, and the amount you need to collect varies from state to state, so you’ll need to check your state and city requirements. You usually only have to collect sales tax in the state you’re active in, but if in doubt, consult an accountant.
Any LLC owner who has any part in the business must pay this tax on their distributive share. In other words, they must pay tax on their rightful share of the LLC’s profits. Owners who are inactive in the LLC, such as those who have invested money but do not work for the LLC, may be exempt from having to pay self-employment taxes on their portion of the profits. Again, if in doubt, consult a local accountant.
Yes, there are some changes depending on the state in which your company operates. For example, the state of California charges a tax on LLCs that take in more than $250,000 per annum. This charge can range from $900 to $11,000.
Some states also levy a yearly LLC fee that isn’t even related to the company’s end-of-year income. This is typically known as a renewal fee, a franchise tax, or an annual registration fee. Most states charge about $100, but California imposes an eye-watering $800 "minimum franchise tax" every year from LLCs. For LLCs formed in 2021, 2022, or 2023, this tax is waived for the first year, but after that, the company must pay.
As we’ve discussed ,there are multiple types of LLC taxes that you may be responsible for paying ,so it’s important to be on top of your financial planning, file the right forms and pay your taxes on time. If you struggle to get the information together and need more time to file your LLC taxes, be sure to request an extension to avoid any penalties. Once your taxes are taken care of, you can concentrate on what matters most: making money by running a successful small business.
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