LLCs are a bit of an outlier in several respects. They play by slightly different rules than other businesses, so it’s no surprise that they are taxed differently as well. However, LLC (or Limited Liability Company) taxes are no more complicated than any other kind of tax. Read on to understand your responsibilities as a member of an LLC during this tax season.
How do LLC taxes work?
Unlike the other business structures, an LLC gets to choose how the IRS taxes it. An LLC will be treated like the structure it is most similar to by default, but the members (shareholders or owners in an LLC are referred to as members) can apply for a different classification.
For example, an LLC with one member will be taxed as a sole proprietorship. One that has two or more members will be taxed as a partnership. If desired, it could be taxed as an S or C Corp.
What’s the benefit in choosing your tax classification? Why, giving away less money, of course! The question is: Which tax classification is most beneficial to an LLC?
Check out our guide to the S Corporation Election
How to choose an LLC tax treatment
There are several factors to consider when choosing how to classify an LLC for tax purposes.
- Which entity has the lowest tax rate? Sole proprietorships, partnerships, and S Corps all pass profits through to their members. That results in only individual taxes being applicable, whereas the profit of C Corps is subject to corporate taxes (which are generally higher than individual taxes).
- Double taxation or not? C Corps pay taxes on company profits before employees and owners are paid. Those individuals are also taxed on their income and dividends. That is known as double taxation. It almost always results in a higher overall level of taxation, but in certain cases (such as choosing not to pay dividends annually) it may reduce the overall tax burden.
- Compensating members/owners. Compensation differs between owners of S and C Corps, and sole proprietorships and partnerships. The former requires owners to be treated as employees and to draw a reasonable salary. In this scenario, they will be paying FICA taxes instead of self-employment taxes (which could result in a lower individual tax burden). Additional benefits of going the corporation route are being able to funnel more pre-tax money into retirement savings and health insurance programs.
- Will the LLC run with operating losses? If the LLC is not a C corporation, losses can be reported on your personal tax return (lowering personal tax burden). C corporation losses, on the other hand, are simply carried forward into the next year to offset future earnings.
In most cases, sole proprietorships and partnerships are treated the same. S Corps are more similar to them then they are to C Corps. To be sure you’re making the best decision possible, consult with a tax attorney or CPA to minimize your tax liability.
If for any reason, you want to change the default designation of an LLC, you’ll have to file Form 8832 – the Entity Classification Election form. Note that the classification change must take effect within 12 months of the filing date.
LLC single member tax requirements
If you’re a one-man-band, the LLC will default to being taxed as a sole proprietorship – and in most cases, that’s just fine. You will pay taxes as a self-employed individual. In this case, your LLC is called a “disregarded entity”.
What that means is that you report all income, expenses, and credits on your personal tax return. For single-member LLCs, there is no additional form beyond those that a sole proprietorship would file. In essence, you’re reporting as if the LLC does not exist and all money flows in and out of your personal accounts.
Forms Required for Single Member LLCs
- Form 1040 – The form used by individuals to file their personal annual income tax return. Starting in 2018, forms 1040A and 1040EZ were replaced by an updated Form 1040.
- Schedule C – The form used by sole proprietorships to report all profts and loss from operating a business.
- Schedule SE – The form used to report self-employment income to calculate Medicaid and Social Security tax. Note that it should include ALL income of an individual – including anything beyond the LLC in question.
LLC partnership tax requirements
If the LLC has more than one member it’s considered a partnership – regardless of the number of members or the equity split. In a partnership, unlike a sole proprietorship, income has to be distributed to each member and reported. The LLC has its own forms to file this time around in addition to the ones filed by the members.
Forms Required for Multi-Member LLCs
- Form 1065 – The Federal Tax Return for Partnership Income. The partnership (or in this case, the LLC acting as a partnership) has to file a Form 1065 itself. This form is purely informational. There are no taxes withdrawn from a partnership at any point. Rather, this lets the IRS know the income, expenses, credits claimed of the business.
- Schedule K-1 – The K-1 is an addendum to Form 1065. It is also filed in the business’ name, not an individual’s. This form specifically details how the profits (and expenses) of the LLC or partnership were distributed among the members.
- Schedule E – Using the information from the Schedule K-1, a member will file a Schedule E as an addendum to their personal Form 1040. The Schedule E reiterates much of the information on the K-1, reporting the net business income and what share was given to the member.
- Schedule SE – As a partial owner of a business, members of a partnership are considered self-employed. Remember that ALL self-employed income has to be reported on a single Schedule SE, even if the individual is a member of several businesses.
LLC S Corporation tax requirements
Being treated as an S Corp is never possible without first applying for it (through the Entity Classification Election form) and being approved by the IRS.
Like sole proprietorships and partnerships, S Corps are not themselves taxed. Members and employees are taxed on their income after it is passed through the S Corp and paid as dividends or salary.
Forms Required for S Corp Taxed LLCs
- Form 1120S – The Federal Tax Return for S Corporations. This is an informational form. S Corps almost never pay any taxes directly. This form simply reports all the income and expenses generated by the company during the year.
- Schedule K-1 – This form is very similar to the K-1 that is used by partnerships. It describes the revenue made by the company and how losses and profits were distributed to members and employees. A copy of the K-1 is sent to shareholders so that they can report dividends on their personal tax returns.
- Schedule E – This form is an addendum to an individual’s Form 1040. It mirrors the information on the Schedule K-1 and reports income gained through the business as well as the revenue generated by the business.
LLC C Corporation tax requirements
LLCs that want to be treated as a C Corporation will need to apply for the privilege using the Entity Classification Election form.
After being approved, the LLC will have the additional privilege of being double taxed! The good news is that reporting those taxes is pretty simple in this scenario. The company pays its taxes and employee and owners pay tax on their income separately.
Forms Required for C Corps Taxed LLCs
- Form 1120 – The Federal Tax Return Form for C Corporations. It is used to report all revenue – profits and losses – as well as credits claimed by the company. This is not an informational form; C corps are taxed at the corporate rate (currently 21% as of 2019).
- Form 1099-DIV – If the C corporation will be paying out dividends to owners, it will also need to file the Dividends and Distributions form. It simply reports what dividends were paid and to whom. Owners receiving these dividends will need to report their earnings on their personal tax returns.
Note that a C corporation may not need to file this every year as dividend distribution is not mandatory (and waiting may be part of your tax strategy).
When do you pay LLC Taxes?
For the most part, individuals and businesses file taxes at the same time. Tax season for the previous year begins on January 1st and ends on April 15th.
Do I have to file taxes if my LLC didn’t make any money?
Yes. Every business is required to report its income or lack thereof. Putting a 0 in the box for profit or even revenue is perfectly acceptable. It may even be beneficial to you. In most cases, the LLC’s profits and losses pass through to the owners. A loss for your LLC means a reduction in personal taxes.
If you make more than $400 in a year outside of a W2 job, you might be liable for self-employment taxes.
There is some lingering public confusion about self-employment tax. It’s often (indignantly) claimed: “You get taxed more when you’re self-employed!”
That’s not really true. The difference is in what point in the process you’re taxed at. It’s true that there is a SECA (Self Employment Contribution Act) tax that you never had to pay at your old job, but that’s because they called FICA (Federal Insurance Contributions Act) when a company pays it. Those two taxes are for the same thing – Medicaid and Social Security.
At a regular job, where you are a W2 employee, your company pays half of it for you and takes the other half out of your paycheck before they hand it to you. That’s why you are paid less than you earn. When you are your own boss you have the unenviable responsibility of putting aside money for it yourself.
Note also that a self-employed individual is expected to pay “Estimated Tax” on a quarterly basis. That includes both income tax and self-employed taxes. Failure to do so may result in fines. For more information, check the IRS’ resources regarding self-employment.
If your LLC has members that have invested but are not directly involved (either by making management decisions or providing services), they are not considered self-employed and are not subject to the Estimated Taxes. Consult with a tax lawyer to see if that applies in your scenario.
Additional LLC taxes and fees
Unfortunately, federal income tax is just one of many taxes an LLC is responsible for. There are additional federal taxes, as well as state and possibly local taxes. To be certain you didn’t miss any, consult with a CPA. Here is a list of further taxes to check for:
- Sales Tax – There is a sales tax on most goods and services in almost every state. If you operate in that state, even if you don’t have a physical location, you will be held liable for paying those taxes to that state. Your business can either eat the cost or pass it on to customers.
Selling goods online across interstate boundaries gets blurry, so consult with a tax attorney.
- Payroll Tax – An LLC is responsible for deducting payroll taxes (like FICA) from a W2 employee’s paycheck and paying them to the state and the federal government.
- State LLC Fees / Registration – Forming an LLC and having it recognized by the state usually incurs a fee. The cost varies widely from state to state. Some states also require annual renewal fees.
- State Income Tax – In addition to federal income taxes, almost every state also requires an LLC pay income tax to them. There are only 7 states that don’t have an income tax requirement:
- South Dakota
- City Business License – Some cities, particularly the large, well-known ones, will charge their own fees for operating in their cities. It usually only applies if the business has a physical location within city boundaries.