There are many different scenarios that affect how an LLC is taxed and this can get complicated. But in general, the IRS treats an LLC like a sole proprietorship or partnership, and therefore it does not pay business taxes. Some states, however, may charge the LLC an annual fee.
How is a limited liability company (LLC) taxed?
An LLC, by default, is taxed the same as a sole proprietor. Their profits are reported on the form Schedule C, which is then integrated with the business owner’s personal tax return. An LLC also has the option to elect S-Corp status, which means they are not taxed on the profits of the business, but rather the salary of the owner. With an S-Corp, it’s a requirement for the business owner to have a reasonable salary in place and pay payroll taxes. The S-Corp will file a tax return separate from the owner on form 1120S, and while the profits of the business are tax-free, the business owner receives a W2 from the business, and this income is reported on their personal tax return.
Types of taxes an LLC has to pay:
As an LLC, you’ll pay self-employment tax at 15.3% on the profits of the business (12.4% for Social Security and 2.9% for Medicare). The profits of the business will also flow through your personal tax return, where you will also pay federal income tax as well as state income tax.
Tax advantages of filing taxes as an LLC:
LLC is a much simpler structure, and since it’s taxed as a Sole Proprietor, taxes can be pretty simplified. Income and expenses are reported on the Schedule C form, and then the profits flow through to the owner’s personal tax return. Often, tax prep fees for an LLC are much lower than those of an S-Corp. An S-Corp comes with plenty of complexities and is more beneficial for a business that has about $30K-$50K of profit. Tax return preparation fees could be more than double those of LLCs, and with S-Corps, there are also the added costs and complexity of payroll. As an S-Corp, it’s a requirement for the owner to be reasonably compensated and be paying payroll taxes.
Flexibility is one of the main tax advantages of an LLC. There are some taxation options available for LLC members that can result in tax savings.
Business expense tax deductions are another tax advantage a limited liability company can have. 20% of business income can be minimized through taxation entities’ pass-through qualifying according to the TCJA. The prime tax benefit to an LLC is that whether the business expenses are regular or ordinary, one gets to write off the LLC expenses. And after the TCJA changes, the regular W-2 employee cannot deduct expenses if it is related to work, such as mileage or equipment.
A limited liability company (LLC) is not a separate tax entity like a corporation; instead, it is what the IRS calls a “pass-through entity,” like a partnership or sole proprietorship. The LLC itself does not pay federal income taxes, although some states impose an annual tax on LLCs.
Common terms you need to know about LLC and tax
Here are some of the common terms and answers to the above question.
SMLLC – Single Member LLC
LLC – Limited Liability Corp – for tax purposes, the IRS classifies businesses as:
• Sole proprietorship
• C corporation
• S corporation
Therefore, an LLC is NOT a tax classification. The IRS treats LLCs as though they are another type of business, and the IRS automatically taxes SMLLCs as sole proprietorships and multi-member LLCs as partnerships, but an LLC can also choose to be taxed as a C Corporation or as an S Corporation. In order to elect a new tax status for the current tax year (assuming calendar year = fiscal year), the organization must file Form 2553 by March 15 of that year. Or for different fiscal years, within the first 2.5 months of the year in which the organization wants the new tax status to be effective.
Disregarded entity – a business entity with one owner that is not recognized for tax purposes as an entity separate from its owner. For example, a single-member LLC is considered to be a disregarded entity (if no election has been made for C or S Corp taxation).
S Corp – Unlike an LLC or a C Corporation, an S Corp is not a type of business entity
• S corporation designation refers to the way a business has chosen to be taxed under the Internal Revenue Code