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 entity that protects business owners’ assets if the company were to be sued or get into financial difficulty. This, along with privacy protection and ease of business setup, makes LLCs an incredibly popular business structure.
Understanding how LLCs are taxed can vary from state to state and be a complicated process. We’ve broken it down for you here, so read on to understand exactly how LLCs are taxed so you can confidently move forward.
How Are LLCs Viewed for Income Tax Purposes?
A limited liability company (LLC) is what the IRS refers to as a “pass-through entity.” This means it’s not a separate tax entity, and the LLC will not have to pay taxes on business income – just the owners’ income. This simplifies tax filings and means that the LLC won’t be double-taxed. However, some states apply additional charges and taxes or require additional filings, so 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. However, the tax benefits for an LLC may be better for many LLC owners.
How Do Single-Member LLCs Pay Taxes?
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 protection of an LLC. You will report your earnings and expenses on Form 1040, Schedule C, or, in certain cases, Schedule E or F, and file LLC taxes with your individual taxes.
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.
How Are Multi-Member LLCs Taxed?
Multi-member LLCs, with two or more members, are taxed as a “pass-through entity” unless you choose corporate tax status. More on that below. 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 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). Each member must complete a Schedule K-1, giving the IRS a complete business picture.
How Are LLCs Taxed as Corporations?
If you elect to have your LLC taxed as a corporation, things can get a little complicated, so it’s worth consulting a certified public accountant (CPA) 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:
LLCs that elect to be taxed as C-Corps are taxed at 21% (with Form 1120). However, this is not common. 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 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 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. In addition, it can be simpler to form a C-corporation than elect to have an LLC taxed as a C-corp.
S-corporations are a popular tax election for LLCs. In terms of tax filings, 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 for the combined employee and employer portions of this Social Security and Medicare tax amount.
Although the company’s owner pays Social Security and Medicare taxes for company employees, you’ll also still need to pay your relevant portion of taxes on the salary you elect to pay yourself.
Some LLC owners use an S-corp to save on self-employment taxes. Of course, the LLC owner will likely incur additional expenses like payroll taxes, accountant’s salary, and administrative fees for payroll processing, all cutting into profit.
Are LLC Members Considered Employed or Self-employed?
LLC members are considered self-employed business owners, so they aren’t subject to tax withholding. Each LLC member must ensure 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.
Do LLCs Collect Sales Tax?
Yes – if you sell taxable services or products, you must 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. You should also double-check both state and federal tax filing deadlines for your LLC.
Do I Still Have to Pay Taxes if I’m an Inactive Member of an LLC?
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 paying self-employment taxes on their portion of the profits. Again, consult a CPA with an understanding of LLC taxation if in doubt.
Do LLC Fees and Taxes Change Depending on My State?
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 make 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, franchise tax, or annual registration fee. Most states charge about $100, but California imposes an eye-watering $800 “minimum franchise tax” yearly 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. Double-check whether you need to pay tax on an LLC with no income.
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’s 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.
How doola Can Help With LLC Taxes
Keeping up with LLC taxes, tax elections, and quarterly tax filings is a big responsibility for business owners. doola offers stress-free bookkeeping for busy founders. Whether you’re just starting your LLC or already have a successful company, doola can help. If you’re looking for the ultimate bookkeeping software made for business owners who want less stress and more time to focus on their core business, get doola books here!
Do LLCs pay taxes?
Yes, LLCs pay taxes. However, as LLCs are considered pass-through entities in most states, the LLC owners will report all earnings on their individual income tax returns.
Can an LLC choose to be taxed as a corporation?
Yes, an LLC can choose to be taxed as a corporation. In many cases, LLC owners elect to be taxed as an S-corporation, which offers some favorable tax treatment. In rare cases, LLCs may elect to be taxed as C-corporations.
What are the tax deductions available to LLCs?
LLCs can take advantage of specific government incentives. In addition, LLC owners can deduct qualified business expenses like professional fees, bank fees, and office supplies.
Can an LLC have a different fiscal year for tax purposes?
Usually, an LLC must use the same tax year as the majority of its owners, which is usually the calendar year. An S-corporation or C-corporation must also usually use the calendar year.
How often does an LLC need to pay estimated taxes?