What you’ll discover:
A Limited Liability Corporation, unlike a corporation (such as a C-Corp or S-Corp), is not a distinct taxable entity. The IRS refers to LLCs as “pass-through businesses,” which essentially means that the tax obligations of the firm “flow through” to you and your co-owners personal income tax.
LLCs are advantageous because they allow you to choose how you wish to be taxed. By submitting the necessary documents with the IRS, you may tax your LLC as a sole proprietorship, partnership, or corporation.
Let’s go through how your LLC will be taxed by default, how your LLC Operating Agreement may provide you more control, what papers you should submit, and how to alter your tax identification if you want to.
The IRS will automatically designate your LLC as a sole proprietorship or a partnership based on the number of members (owners) in the LLC. If you are the single member of your LLC, the IRS will tax it as a sole proprietorship. If your LLC has more than one member, the IRS will recognize it as a partnership.
As previously stated, an LLC is a “pass-through entity.” This implies that if your LLC produces a $20,000 profit, you must pay taxes on your portion of the profit on your personal tax return. Assume your LLC has four partners who each own an equal portion of the firm. You will each pay taxes on a $5,000 profit. If your LLC is your sole property, you will pay those taxes on your 1040 tax return.
Every limited liability company should have an operating agreement (you can read more about that here.) Although most states do not need an operating agreement, it is recommended that one be created. Operating agreements are simply contracts between the members of an LLC defining the structure of the firm, including – for our purposes – the tax structure of the organization. Check to see whether your state needs you to register your operating agreement.
Beyond that, you’ll need to submit Form 1065 with the IRS. The IRS utilizes this to guarantee that each LLC member is accurately reporting their LLC revenue. You should also send each member a Schedule K-1 so that everyone knows their portion of the earnings and losses in writing.
After that, each LLC member will be taxed individually on their 1040 tax return.
Some limited liability companies choose to be taxed like corporations (like a C-Corp or S-Corp). But why is this so? The most typical reason is because their company want to maintain a significant portion of its income in their LLC, and these so-called “retained earnings” are normally taxed at a lower rate than they would be on a personal 1040 tax return.
To opt out of corporation taxes, you must submit a “Entity Classification Election” (IRS Form 8832.) There should be a part on it where you may choose to be taxed as a company. If you opt to be taxed as an S-Corp, you must additionally submit IRS Form 2553, “Small Business Corporation Election.”
Here are a few additional things you should bear in mind.
