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When choosing a business entity for your company, taxes are of utmost importance. The amount of taxes you must pay to the government is directly connected to the structure of your business. A limited liability company (LLC) is a type of business that is registered with the state and provides personal liability protection for owners.
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An LLC is generally treated as a pass-through entity for federal income tax purposes. This means that the LLC itself does not pay taxes on business income. LLC members pay taxes on their share of the LLC’s income. State or local governments may charge additional LLC taxes. Members can elect for the LLC to be taxed as a corporation instead of a pass-through entity.
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There are several types of LLC taxes. The federal government, as well as state and local governments, impose these taxes. All LLC members are responsible for paying income taxes on any income they earn from the LLC as well as self-employment taxes. Depending on what you sell and whether you are employed by someone else, you may also be responsible for paying payroll taxes and sales taxes. To complicate matters further, an LLC may elect to be taxed as a separate business entity.
In this guide, we’ll cover the full range of LLC taxes, what you’re liable for, and options for reducing your tax bill. Understanding your tax burden in advance can help you make smarter financial decisions.
There are a wide range of business taxes that owners of an LLC may be responsible for. Federal, state, and local income taxes represent the biggest burden for most business owners. The way you file and pay income taxes depends on whether your LLC has one owner (a single member LLC) or many owners (a multi-member LLC).
Generally, the IRS treats a single-member LLC as a disregarded entity for federal income tax purposes. According to Vincent Porter, a certified public accountant (CPA) at MyTexasCPA, “A disregarded entity means that the LLC does not have to file a separate income tax return to report income and expenses. The income and expenses go directly to the member’s tax return.
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In other words, as the sole owner of an LLC, you report business income and expenses on Form 1040, Schedule C, just like a sole proprietor. If, after deducting business expenses, the LLC generates income for the year, the owner owes taxes to the IRS according to their personal income taxes. If the LLC operates at a loss for the year, the owner can deduct the business losses from their personal income.
This process generally works the same way at the state and local level. For example, an owner of a New York City LLC will report business income on their federal and state personal tax returns. Income is subject to the owner’s federal, state, and local personal income taxes. The key is that you are only taxed on income that is in the state or locality. According to Porter, “States will tax an LLC with respect to the amount of sales, salaries, or property owned in that state. In other words, if the federal income is $100 and the company has $50 payroll in New York and $200 in wages elsewhere. , New York will tax $25 in state income ($50/$200 x $100).
Some states charge different LLC taxes or fees. California, for example, charges an $800 annual LLC tax, with the annual fee varying based on your LLC’s California income. Consider these LLC taxes when choosing your business structure and making budgeting decisions.
Multi-member LLCs are treated as pass-through entities for federal income tax purposes. Like a single-member LLC, this means the LLC doesn’t pay its own taxes. Instead, each member pays business income tax according to their ownership stake in the LLC. Thus, the LLC’s tax rate is consistent with each member’s individual income tax bracket.
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If, for example, two members of an LLC have a 50-50 ownership split, each owner is responsible for paying taxes on half of the business’s profits. Each owner can also claim half of the tax deductions and tax credits to which the LLC is entitled, and write off half of the losses. This type of tax works almost like a partnership.
A multi-member LLC must file several tax forms with the IRS, including Form 1065, US Return of Partnership Income—an informational return that must be filed annually with the IRS. The LLC must also provide each owner with a completed Schedule K-1 by March 15 of each year. The Schedule K-1 summarizes each owner’s share of the LLC’s income, losses, credits, and deductions. Each owner will include their Schedule K-1 with their personal income tax return filed with the IRS.
Pass-through taxation continues at the state and local level. Most states have their own equivalents to Form 1065 and Schedule K-1. As mentioned above, some states such as California charge additional taxes on LLCs.
So far, we’ve discussed the default income tax rules for LLCs, but things can get a little more complicated. Members of an LLC can elect for the business to be classified as a C-corporation or S-corporation for tax purposes. The voting and approval procedure required to make this change can be found in the LLC’s operating agreement.
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Your LLC can elect to be taxed as a C-corporation by filing Form 8832 with the IRS (your state may also require additional forms for a change of tax status). If you make this change, your LLC will be subject to the 21% federal corporate tax rate. You must file taxes using Form 1120, U.S. Corporate Income Tax Return. You will also pay state and local corporate taxes where your business is located.
To elect for S-corporation tax status, file Form 2553 with the IRS. An S-corp is taxed like a pass-through entity, similar to an LLC, with some differences in how taxes and distributions from the business are handled. To file taxes for an S-corp, submit Form 1120S, U.S. Income Tax Return for S-corporation, to the IRS.
Note that choosing corporate tax status does not affect your LLC from a legal perspective. Legally, your business will continue to operate as an LLC. You should consult a tax professional to determine whether you may benefit from corporate tax status. A corporation is taxed differently than an LLC, and a corporation is eligible for more deductions and credits.
LLCs with employees must collect and pay payroll taxes. These taxes include unemployment taxes, social security taxes, and Medicare taxes. Employers pay unemployment taxes to fund unemployment benefit programs. Employers and employees share in paying social security and Medicare taxes (called FICA taxes under the Federal Insurance Contributions Act). Employers must withhold the employee’s share of these taxes, including income taxes, from their employees’ paychecks.
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Payroll taxes are filed using IRS Form 940 and Form 941. Form 940 is filed annually and is used to report the employer’s unemployment tax obligations. Form 941 is filed quarterly. Businesses use this form to report withheld income taxes and employer and employee shares of social security and Medicare taxes.
One thing to note is that these taxes are not paid when you file tax forms. The IRS uses a pay-as-you-go system for payroll taxes, so you must deposit your payroll taxes throughout the year according to the schedule set by the IRS. Deposits can be made using the Electronic Federal Tax Payment System (EFTPS). Unemployment taxes are deposited quarterly, while social security and Medicare taxes are deposited monthly or semi-weekly depending on the amount of your tax liability. The IRS instructions for Form 940 and Form 941 will help you determine your deposit schedule.
For reference, here are the current federal tax rates for unemployment taxes, social security taxes, and Medicare taxes:
Along with federal payroll taxes, states and local governments often impose additional payroll taxes. For payroll taxes that the employee is responsible for, you must make the necessary withholdings and remit the payment to the state or locality. You pay employer tax directly to the tax agency.
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Members of an LLC are not considered employees. However, under the Self Employment Contributions Act (SECA), you still owe social security and Medicare taxes to the IRS. You pay these taxes directly to the IRS in the form of self-employment taxes. The general self-employment tax is 15.3%, and it is divided into several parts:
If your LLC sells taxable goods or services, you must collect the sales tax from your customers and remit the tax to the state or local tax agency. It depends on what goods and services are taxed