The Ultimate Guide To LLC Taxes

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One of the most important decisions you’ll ever make about your small business is which kind of legal structure to adopt. There are plenty of options available, from Sole Proprietorships to incorporation, and the decision you make will have wide-ranging effects on all aspects of your business. Most notably, the legal structure you choose will have significant effects on your tax burden.

For a lot of small businesses, the ideal structure is the Limited Liability Company, or LLC. There are plenty of reasons why LLCs are so advantageous, not least built-in tax flexibility. This post will explore the topic of LLC taxation in greater detail.

Understanding LLCs

What exactly is an LLC?

The LLC is one of the most popular structures for American business owners. It’s been around since the 1970s and has grown in popularity every year since. When you register an LLC, you’re actually creating a whole new legal entity. In other words, there’s a legal distinction between the business and its owner, which isn’t the case with Sole Proprietorships.

What exactly is an LLC

LLCs are well-known for providing personal wealth protection. As a business owner, you can keep business assets/liabilities in one pot and personal assets/liabilities in the other. This allows you to shield your personal wealth from creditors as well as from litigation. Starting an LLC requires you to file Articles of Organization at the state level, to pay a nominal LLC filing fee, and to hire a Registered Agent.

(For examples of third-party services, check out Northwest Registered Agent reviews.) Again, LLCs are also well-regarded because they provide business owners with some flexibility as to how they report to the IRS. That’s what we’ll get into next.

LLC taxes: An overview

Generally speaking, LLCs pay taxes on a pass-through basis. This means the LLC itself does not pay any taxes on its business income. Instead, the LLC’s members can each claim their share of the business profits on their individual tax returns.

While this is the default tax status for LLC, it’s important to note that the LLC can opt into corporate taxation at any time. And, it’s worth pointing out that, in rare instances, there may be some LLC-specific taxes levied by the state or the municipality.

To get a clearer sense of how LLCs are taxed, it’s important to look more closely at the distinctions between single-member and multi-member LLCs.

Taxation for single-member LLCs

When you have an LLC with just one member, the default position is for the IRS to view the business as a disregarded entity. This simply means that the business does not file its own separate tax return, and it does not claim any income or report expenses. Instead, all income and expenses are simply reported on the individual return of the LLC’s sole member.

Taxation for single-member LLCs

In more practical terms, this means that if you are the only member in an LLC, you can report income and expenses using a Form 1040, Schedule C. This is the same document you’d use for reporting taxes if you were a Sole Proprietor.

If you deduct expenses and find that the LLC is still profitable for the year, then you’ll pay taxes on the business income at your normal rate. If the company isn’t profitable, however, then you’ll deduct losses from your personal income.

A final note: Single-member LLCs in California must also pay the state’s flat-rate LLC tax, which is currently set at $800. Right now, no other state has an LLC-specific tax.

Taxation for multi-member LLCs

Taxation for multi-member LLCs works in much the same way. These businesses are considered to be disregarded entities, which means each member of the LLC reports their share of the income on their income tax return. Different members may have different stakes in the company, and they may be in separate tax brackets. In other words, the members of the LLC may not pay the same amount on their tax returns.

Taxation for multi-member LLCs

Actually filing taxes in a multi-member LLC is a little more complicated than it is with single-member LLCs, and requires a number of different forms. It’s best to work with a tax preparation professional to ensure the right documents are in place, but generally multi-member LLCs require Form 1065, U.S. Return of Partnership Income, and individual K-1s.

One more thing: Just like with single-member LLCs, multi-member ones may need to consider some state or regional specifics, notably that flat-rate LLC tax in California.

Choosing corporate tax status

Pass-through taxation is the default, but LLCs can also elect to be taxed on a corporate basis. Specifically, they can choose from S-Corp or C-Corp taxation.

Choosing corporate tax status

In a single-member LLC, this change can be made unilaterally by the one member. In a multi-member LLC, the partners must vote. The voting process can vary from one LLC to the next, and is typically outlined in the Operating Agreement.

Usually, making the switch to corporate taxation is not a wise move, especially not for smaller LLCs. For large companies with more complex tax strategies, however, corporate taxation may sometimes be a boon. Certainly, it’s good to know that the option exists.

What about payroll taxes?

Finally, LLCs that have hired employees will need to account for payroll taxes. Payroll taxes cover things like Social Security and Medicare. These taxes are not included in regular income tax returns, which means the LLC will need to file Form 940 and Form 941.

LLCs provide significant tax benefits

The bottom line: Choosing the best legal structure for your company can have a big impact on taxes. And for many companies, the most advantageous option, tax-wise, is the LLC. Consider forming an LLC for your business, and discover some of the benefits come tax time.

About the author 

Peter Keszegh

Most people write this part in the third person but I won't. You're at the right place if you want to start or grow your online business. When I'm not busy scaling up my own or other people' businesses, you'll find me trying out new things and discovering new places. Connect with me on Facebook, just let me know how I can help.

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