How Is an LLC Taxed: In-Depth Guide [Types of Taxes Explained]
Last Updated: February 2, 2023
A Limited Liability Company (LLC) is a business structure that is becoming increasingly popular in the US. One of the main reasons for the growing popularity is how LLC taxes are organized. Since the IRS doesn’t recognize LLCs as taxable entities, the owners have the flexibility to choose how their company is taxed. This article addresses the taxation options for LLCs and what they need to pay.
How Is an LLC Taxed?
The Internal Revenue Service treats an LLC as a pass-through entity for tax purposes, which means that an LLC doesn’t pay taxes on business income. How is an LLC taxed? There are several ways an LLC can be taxed. But first, the company’s tax classification can be changed at will by filing a form with the IRS—another convenience provided by LLCs.
If the owner is the only LLC member, the IRS considers the company a sole proprietorship, also known as a disregarded entity. In such cases, the LLC’s income is taxed as personal income.
But if the LLC has more than one member, the taxation of an LLC is considered identical to that of a general partnership, and the LLC members must pay taxes on their share of the profits.
In addition to paying taxes on the profit, LLC members must pay self-employment taxes as well. Another option for LLCs is to be taxed as corporations. If the LLC is selling goods, it must also pay sales taxes. And if the LLC has employees, it’s responsible for payroll taxes.
State taxes vary, depending on the location of the business. The LLC and taxes must be compliant with all changes in the tax law so that the owners are not liable for any incorrectly filed tax returns. If you’re considering starting your own LLC, you should consider getting in touch with the top LLC service, which can help with the entire process.
LLC Income Tax
Filing taxes for an LLC includes paying business taxes at the local, state, and federal level is the most significant expense for businesses. Income tax is based on your business’s net income for the tax year and if the payment was divided by multiple owners. To determine the net income, owners must fill out Schedule C on their tax returns.
Single-Member LLC Taxes
LLCs owned by a single owner are treated as disregarded entities for federal tax purposes, meaning that the LLC owner is not required to file a separate tax return to report the business’s income and expenses. Instead, the LLC tax is filed on Form 1040, Schedule C—the same as a sole proprietor. If the LLC had generated a profit in the tax year, the owner must pay taxes to the IRS at their income tax rate.
How is an LLC taxed if the company didn’t generate a profit or operated at a loss during the tax year? In such cases, the owner can deduct the losses from their income and receive a deduction from the state. A single-member LLC is cost-effective because there aren’t any additional tax filing costs for the owner, and they are not subject to double taxation.
Multi-Member LLC Taxes
Multi-member LLCs are regarded as pass-through entities for taxation purposes, meaning that LLC taxes are not reported on a separate return. Still, members report them on their returns. Each member in a multi-member LLC pays taxes in proportion to the ownership stake in the company. Thus, the LLC tax rate is adjusted to each member’s tax bracket, and they are only responsible for paying taxes on their shares and profits at their tax rate. If deductions or credits are claimed, each owner must claim them individually—much as partners would do in a registered partnership.
Pass-through taxation is implemented at both state and local levels—although some states choose to impose additional taxes for LLC. Additionally, the members must annually file Form 1065, and Schedule K-1 has to be attached to their tax return because it summarizes the member’s share in the company.
First, however, how to file taxes for an LLC as a corporation needs to be seriously considered? If the owners opt for filing as C-corporation of the LLC, they will need to file their taxes on Form 1120 and pay local and state corporate taxes based on the business’s location.
Filing as an S-corporation means that Form 1020S needs to be submitted, but the company is taxed as a pass-through entity. Although there are some differences in the ways business distributions and salaries are taxed, the tax status of an LLC taxed as an S corp is similar to that of a single-member LLC. Therefore, changing the LLC taxation status to a corporation will not affect the legal standing of your company; it will continue to be regarded as a Limited Liability Company.
Even though corporations are eligible for more tax deductions and credits, the best course of action is to consult a tax professional to determine whether your company will benefit from filing as a corporation, i.e., a separate tax entity. If you’re having trouble managing your business’s tax situation, you can consider getting help from the top-rated registered agent.
Benefits and Drawbacks of LLC Tax Options
|Tax status||Main benefits||Main drawbacks|
|Single-member LLC||No double taxation; no separate tax returns.||Self-employment taxes.|
|Multi-member LLC||LLC tax rate equals the personal tax rate of the member; members can claim deductions.||Deductions can be claimed individually for each member’s share of the losses.|
|S-corporation||Pass-through taxation.||Less flexibility for outside investments.|
|C-corporation||No self-employment tax; no business income on a personal tax return.||Local and state taxes are paid based on location.|
LLC Self-Employment Tax
In the eyes of the state, members of an LLC are not considered employees but regarded as self-employed. Their earnings aren’t regarded as salaries, so they must pay self-employment tax, including Social Security taxes and Medicare taxes. The self-employment LLC tax rate is 15.3%, annually adjusted for inflation. Out of the 15.3%, 12.4% goes to Social Security (on earnings up to $137,700), 2.9% to Medicare tax, and 0.9% goes to Medicare surtax (on earnings over $200.000).
How Are LLCs Taxed if Their Employees Are Not Regarded as Employees?
Self-employment taxes are not paid by the LLC but are included on Schedule SE, attached to the individual’s tax return.
The Federal Insurance Contributions Act (FICA) taxes used for funding Social Security and Medicare are paid by both the LLC owner and LLC employees, each paying half of the amount.
The LLC members must be careful when filing for self-employment taxes because the IRS might claim that they had underpaid taxes and cause problems for the company.
LLC Payroll and Sales Taxes
Any LLC with employees must pay payroll taxes, including unemployment taxes, Medicare, and Social Security taxes. Employees need to pay their share of these taxes. Consequently, employers withhold the allotted amount from their paychecks.
How to File Taxes for LLC Payroll Tax?
There are two forms for filing payroll tax: Form 940 (filed annually) and Form 941 (filed quarterly). These taxes, however, are not paid when the tax forms are filed—a pay-as-you-go system requires taxpayers to deposit payments throughout the year, according to a previously determined schedule. Instead, local and state governments impose their payroll tax—in addition to the federal payroll tax—so LLC members and employees must pay these taxes.
How Does an LLC Pay Taxes on Sold Goods?
LLCs must also pay sales tax on any physical goods or properties they sell. Goods and services subject to sales taxes are determined by the state or region where your business sells these products. Forty-five US states impose sales tax exemptions, including Alaska, Delaware, Montana, Oregon, and New Hampshire. But even though Alaska and Montana do not charge sales tax, they allow regions to levy the tax.
Does an LLC Pay Taxes on Its Sales in Each State?
Whether or not you must pay sales tax is determined by a sales tax nexus, which determines if you have a sufficient connection with a particular region or state for them to charge you sales tax. The majority of states that charge sales tax set a destination-based tax rate, which is specified on the product or service delivery location. Some states have opted for an origin-based tax rate, taxing services or products based on the company’s location. If the LLC conducts business in multiple states, it’s a good idea to use an online point-of-sale (POS) platform, which automatically calculates the taxes for an LLC in each state where the company pays sales taxes.
LLC State Taxes
The LLC tax structure is designed so that the company is not responsible for paying state taxes, but the LLC owners do so on their returns. Some states charge a state tax based on the amount of income an LLC has reported—in addition to the income tax already owed to the state.
Several states have a different system in place, where they charge an annual fee, known as a franchise tax, renewal fee, or annual registration fee. These annual fees usually cost around $100.00. Do LLC pay taxes in the state you plan to base your company in? Not all states charge state taxes or fees.
LLC Tax Deductions
One of the LLC tax benefits is that you don’t have to pay taxes on your company’s money to cover expenses. Instead, you can deduct all business expenses from your income, which lowers the profits you must report on your tax return. These deductible expenses include all advertising costs, travel expenses, equipment costs, and start-up costs for your company.
The 2017 Tax Cuts and Jobs Act allowed LLC owners to become eligible for a new LLC and tax deduction. Both single-member and multi-member LLCs can deduct up to 20% of the net income of the pass-through entity for income tax purposes. However, suppose their taxable income exceeds the determined annual threshold. In that case, the deduction is limited to a 50% deduction on the money paid to employees, or 25% of employee payments, with an additional 2.5% deduction on the value of the company’s properties. LLCs taxed as C-corporations are not eligible for this deduction.
LLCs can be taxed in different ways, depending on their income, company structure, and location. After the owners choose the tax status of the LLC, they must attach and file all the appropriate forms in due time. By filing the LLC tax return correctly and on time, owners can focus on other aspects of the company’s operations.
LLCs are allowed excellent tax flexibility. As a result, LLC taxation rates are lower than those of other similar businesses (partnerships, sole proprietorships), making them a popular option for establishing a small business.
Single-member LLCs are taxed in the same way as sole proprietorships. The company, itself, isn’t taxed as a business entity, but the owner reports all LLC profits on individual returns. For this purpose, Schedule C must be attached to the 1040 tax return and submitted to the IRS.
Since a single-member LLC owner is not regarded as an employee, how is an LLC taxed? Earnings from an LLC are regarded as self-employment income, and the owner must pay self-employment tax on these earnings.