LLC taxes: The need-to-knows
There are multiple nuances to LLC taxes. However, before we can jump into the tax details it’s helpful to provide a quick definition. Along the way, we’ll point out the benefits and drawbacks that come with operating an LLC.
LLC is short for Limited Liability Company. An LLC is an entity set up under state law and, as its name indicates, provides liability protection for its owners, who are referred to as “members.” An LLC doesn’t have a special tax return for federal tax purposes; instead, an LLC is taxed as a sole proprietorship, partnership, or corporation.
LLC tax benefits
There are multiple LLC tax benefits. Here are a few:
1 – It’s a pass-through business entity
This means that your earnings as an LLC are passed straight through to its member(s), without paying federal taxes first. In contrast, earnings from a C corporation are subject to double taxation. This means that a C Corporation pays taxes and then their shareholders pay taxes on their dividends.
2 – It’s flexible
As an LLC operator, you can choose the way your business is taxed. An LLC will be taxed under default rules depending on how many members are in the LLC, but the LLC can elect a different tax treatment. Here’s how the LLC will be taxed:
Single-member LLC taxes
For federal tax and generally state tax purposes, a single-member LLC is taxed as a sole proprietorship. (As a default, single-member LLCs should file taxes annually using Schedule C, which is part of the individual tax return 1040.)
Multi-member LLC taxes
Multi-member LLC taxes are different than single-member LLC taxes. As a default, multi-member LLCs with two or more members are taxed as a partnership. (LLC partnership taxes are filed on Form 1065, with Schedule K-1 (Form 1065) issued to each partner to report each partner’s annual profits and losses for federal tax purposes.)
Members of an LLC taxed as a partnership should report profits and losses via Schedule E, which is part of the individual tax return 1040. Here, the LLC’s profits or losses are the responsibility of each member in proportion to their distributive share. Additionally, some states require members to pay a special business tax, sometimes called an annual franchise tax or business entity tax.
Electing corporation taxes
An LLC with any number of owners can elect to be treated as a corporation for tax purposes by filing elections with the IRS (Form 8832 for C corporations, Form 2553 for S corporations).
- C corporation (Owners use Form 1120 to file your corporation’s federal taxes)
- S corporation (Owners use Form 1120-S to file your corporation’s federal taxes)
3 – It allows a business to be taxed as a corporation without forming one
Single-member LLCs are generally less expensive to run and generally involve less paperwork than other types of businesses.
For instance, corporations observe certain corporate formalities that may include additional steps and precautions to ensure the corporation remains a legally distinct entity from its owner, such as holding board of director meetings, shareholder meetings, documenting decisions, tax requirements, administrative burdens, and additional paperwork.
Multiple-member LLCs can be taxed as a partnership or S corporation, this combines the tax benefits of passthrough taxation with the lower administrative burdens of an LLC.
Considerations beyond LLC taxes
Many small business owners choose to set their business up as an LLC because it provides similar limited legal liability as a corporation. By contrast, if your business is organized as a general partnership or sole proprietorship, your business and personal debts have less creditor protection, meaning your business liabilities can extend to your personal assets.
LLC taxation drawbacks
There are a few LLC taxation drawbacks. Here are a few:
1 – It’s subject to additional tax amounts and reporting
Like any business, an LLC business owner is subject to self-employment tax if the business is taxed as a sole proprietorship or partnership. Paying self-employment tax is like paying both the employer and employee portions of employment taxes. For a traditional employee (who files a W-4 Form) who is not an LLC owner, the LLC will pay only the employer share of employment tax and will withhold the employee share from wages.
Your LLC’s income isn’t subject to income tax withholding, so you may have to pay estimated tax payments each quarter to fulfill your federal income tax obligation.
Additionally, many states require an LLC to file and pay annual registration fees.
2 – You may be limited in what you can and can’t deduct
There are multiple small business tax deductions you can take to offset your tax bill. But, as an LLC, there are limits to what you can deduct. For example, a single member LLC may not be able to deduct or amortize organizational costs if total organizational costs exceed $5,000.
More LLC tax filing tips and hands-on guidance
Now that you’ve learned about LLC tax filing, you may be wondering how to file your small business taxes.
Luckily, we’re here to help. At each Block Advisors location, our tax pros can help you file your taxes if you have an LLC and make sure you get every credit and deduction you deserve.
Let us help you navigate your small business taxes so you can spend time on what you love.