Filing LLC Taxes
When you run a small business, it's crucial to understand taxes. If your business is a limited liability company (LLC), the way you file taxes can vary. The Internal Revenue Service (IRS) usually treats an LLC as a pass-through entity for federal tax purposes. Pass-through taxation means that the business's profits and losses pass through the company to individual members. Rather than the company, the individual members must report the members' share of the profits on their individual tax returns.
On rare occasions, an LLC's members will choose to be treated as a corporation for federal tax purposes. However, in most cases, businesses structure themselves as LLCs to enjoy the same pass-through tax status as sole proprietorships and partnerships.
This article will explain how LLCs are taxed and guide you through different aspects of LLC tax filing. Whether you're a sole proprietor with a single-member LLC or part of a multi-member LLC, you'll learn about federal and state tax requirements, tax deductions, and more in this article.
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How Are LLCs Taxed?
An LLC is a flexible business entity with pass-through taxation. Pass-through taxation is a benefit that is available for business owners who choose the LLC business structure to avoid double taxation. Double taxation happens with corporations when the business itself pays tax on its income, and that income is taxed a second time when it is distributed to the shareholders.
When an LLC chooses pass-through taxation, the owners will report the business's income or losses on their personal income tax return instead of the business paying the tax on its income. Essentially, the business's income is treated as the personal income of the LLC members.
Filing Federal Tax Returns as a Single-Member LLC
When an LLC has a sole owner, the IRS automatically classifies it as a sole proprietorship for tax filing purposes. This is called a single-member LLC. The single LLC member must file a Form 1040 income tax return and report business income and losses on a Schedule C, Profits or Loss From a Business. Schedule C is attached to your personal federal income tax return.
Remember to keep track of all business expenses, as they can lead to valuable tax deductions. It's also important to keep your personal and business bank account information separate for tax purposes.
Filing Federal Tax Returns as a Multiple-Member LLC
For a multi-member LLC, each member files their share of income on a personal tax return. The LLC must file an informational return on Form 1065, U.S. Partnership Return of Income, including a Schedule K-1. The Schedule K-1 is used to report the total income and losses that pass through to the members. Each member must then report that information on their personal Form 1040 tax return and attach a Schedule E, Supplemental Income and Loss.
The IRS automatically taxes an LLC with more than one member in the same manner as a partnership unless the LLC opts for tax treatment as a corporation. For this reason, it's essential for members of an LLC to agree on how to allocate income and expenses. The IRS requires LLC members to pay taxes on their distributive share, which is equal to the percentage of each member's interest in the company.
An LLC can distribute its profits as a special allocation where one or more members get more than their distributive share and other members get less. However, unless the company can show an economic reason for the special allocation, each member will still be taxed on their distributive share of the income.
Paying Estimated Taxes
An employer's taxpayer usually pays much of their state and federal taxes through withholdings from their paycheck, but because no taxes are withheld from the profit distributions made to members in an LLC, the members must pay estimated taxes on a quarterly basis to the IRS.
A member's tax payments are based on rough estimates of the tax they will owe at year's end, and you should receive a refund of any overpayments made during the year after you have filed your personal tax return. Small business owners, including LLC members, often need to pay estimated taxes quarterly. Estimated taxes cover income tax and self-employment taxes.
Paying Self-Employment Taxes
The IRS requires LLC members to pay the federal self-employment tax on the profits received by the company if they have been active in the business. The self-employment taxes will cover both the employee and employer's portion of the Social Security and Medicare taxes that an employee owes. The self-employment tax rate as of 2023 is 15.3%.
As a general rule, the self-employment tax applies when a member participates in the trade or business for more than 500 hours in the tax year. It also applies when the member works in an LLC that is a professional service business in the field of health, law, engineering, architecture, accounting, actuarial, or consulting. The IRS may not require non-active LLC members to pay self-employment taxes.
Members must report self-employment taxes on a Schedule SE. LLC members are responsible for paying the entire 15.3% (12.4% for Social Security and 2.9% for Medicare). Members can deduct half of the self-employment tax paid from their adjusted gross income.
Electing Corporate Tax Treatment
Some LLCs choose to be taxed as a C-corporation (C-corp). This means the LLC pays corporate income tax on profits. Any dividends paid to members are also taxed at their individual rates. Electing as a C-corp can be beneficial for businesses that plan to reinvest their profits rather than distribute them. An LLC can choose corporate tax treatment because members must pay taxes on all profits, regardless of whether they are distributed to the members.
The corporate tax option may be beneficial if the LLC chooses to keep a significant amount of profits in the business to contribute to its growth. That is because the corporate tax rate is generally lower than the individual income tax rate would be on that income if it was distributed, and since there is no distribution, those profits are not double-taxed as income to the members.
An LLC may elect corporate tax treatment by filing a Form 8832, Entity Classification Election, with the IRS. The LLC must also file Form 1120, U.S. Corporation Income Tax Return, each year the election applies.
Filing State Income Taxes
LLC members must also file state income tax returns. Like the federal government, most states allow LLC members to pay taxes on profits through personal tax returns. A few states also require members to pay an additional tax on the income made by the LLC.
For instance, in some states, a member may have to pay a tax on LLC income that exceeds a certain amount. Other states may require the LLC to pay an annual fee, sometimes called a franchise tax or a renewal fee.
Since the requirements vary, it's important to understand your state's laws. These laws include rules regarding business taxes, sales tax, and any state-specific tax credits you might qualify for.
Tax Deductions for LLCs
Understanding tax deductions is key for a small business owner to minimize tax liability. As an LLC, you can deduct legitimate business expenses from your income. This includes costs like office supplies, business travel, advertising, and employee salaries. Additionally, home office deductions are available if you use part of your home exclusively for business. It's important to keep detailed records of all expenses to substantiate these deductions.
Newer tax laws may also offer specific deductions, like the Qualified Business Income Deduction. This can significantly reduce taxable income for eligible small businesses. Consulting a tax professional can help you identify and maximize these deductions for your LLC.
LLC Tax Questions? Get Peace of Mind With a Tax Attorney's Help
There is some flexibility when it comes to paying your LLC taxes. There are advantages and disadvantages to paying as a sole proprietorship, partnership, or corporation. Sitting down with a qualified tax attorney can help you determine which one works best for you.
Speak with a tax law attorney near you today.
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