A limited liability corporation (LLC) does not pay business taxes. Instead, LLC revenue is reported on the member’s personal tax return.
This permits LLCs to avoid the double taxes that a corporation would face while yet benefiting from limited liability protection.
Learn the fundamentals in our How Is an LLC Taxed tutorial.
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Basics of LLC Taxation
For federal income tax purposes, LLCs are considered as a pass-through company by default. This implies that LLCs do not pay federal income taxes at the corporate level. According to the LLC operating agreement, LLC revenue is passed through to members’ personal income tax returns depending on their proportion of ownership. Individual income tax rates are then applied to the income.
Distributions or draws are payments provided to members. Self-employment taxes apply to distributions. Some LLCs may benefit from electing S corporation tax status in order to decrease self-employment taxes.
Taxes on a Single-Member LLC
The IRS treats single-member LLCs as “Disregarded Entities.” This simply implies that the IRS disregards the form of your company (i.e., the fact that it is a single-member LLC) and taxes you as if you were a sole proprietorship. The money earned by the LLC is recorded on your personal tax return at the end of the year.
You may pay yourself a dividend from your LLC earnings. You must pay self-employment taxes on your distribution, but you do not have to pay income tax on the distribution since you previously paid income tax on the LLC’s entire earnings.
Taxes on Multi-Member LLCs
The IRS normally taxes a multi-member LLC as a partnership. This implies that LLCs do not pay federal income taxes to the IRS, and all earnings are distributed to LLC members in accordance with the partnership operating agreement. The taxes are subsequently paid to the IRS by the LLC members on their individual tax filings.
A multi-member LLC, like a single-member LLC, allows each owner to receive a dividend from the LLC’s revenues.
S Corp and C Corp are two other LLC tax structures.
The default tax structures—”disregarded entity” for single-member LLCs or “partnership” for multi-member LLCs—are probably the most suited for most persons founding an LLC. These are the usual tax structures for limited liability corporations, and they do not need a specific election when the company is formed.
However, under certain conditions, both single-member and multi-member LLCs might decide to be taxed as corporations. C corporation (C corp) and S Corporation (S corp) are the two company tax classes.
A C company pays taxes on its net profits after deducting all operational expenditures. The gains are subsequently distributed to shareholders, who pay income tax on the distributions. This is frequently referred to as “double taxes.”
An S corporation enables a company’s member(s) to save money on taxes. It is a tax categorization with unique criteria that might benefit your firm if your profits are large. However, before making a choice, it’s critical to grasp the fundamentals of a S corporation and what changes may be in store for your company if you choose S corp status.
These tax arrangements may be chosen when you file for your LLC’s EIN (Employer Identification Number) or later.
Federal Income Taxes on LLCs
You must still file with the IRS regardless of the tax categorization you choose for your LLC.
All owners must complete Form 1040, your individual income tax return, and the accompanying schedules:
Schedule C: The form for reporting revenue from your company.
Schedule SE: The form used to file and pay self-employment taxes.
Schedule E is the form used to record income from rental homes and other assets.
Multi-member LLCs and special entities will need to complete additional paperwork. In addition to Form 1040, partnerships must submit the following:
Form 1065: This is the form used to record your company’s profits and losses.
Schedule K-1: The form used to record your profit portion as an individual owner.
State Income Taxes on LLCs
Because LLCs are “pass-through” organizations, they are not required to pay separate state taxes. That is, individual members, not the LLC, pay state taxes.
Here are some examples of typical state taxes:
Franchise Tax: Some states levy this tax, which is calculated depending on how much an LLC makes each year.
Sales and Use Tax: If you sell tangible things, customers pay this tax to you, and you pay it to your state or local government.
Gross Receipts Tax: A gross receipts tax, like a sales tax, is paid by the seller rather than the customer.
Withholding Tax: Income deducted from employee paychecks and remitted to the government.
Unemployment Insurance (UI) Tax: UI is a tax that is levied on those who receive unemployment benefits. State legislation determines tax rates.
Business Expenses for an LLC
Certain costs may be deducted from your taxes as a company. According to the IRS, a deductible business cost must be both “ordinary and essential.” In other words, your company may deduct all costs that assist it flourish.
Tax-deductible costs may encompass a wide range of items; here are a few examples:
Office equipment
Rent and general upkeep
Permits and licenses
Insurance for Advertising
Some costs, such as travel and entertainment, are more difficult to deduct. These categories contain cost restrictions, extra phrases, or must be capitalized.
Expenses are, of course, only deductible if they are “acceptable.” You may believe that a rooftop Jacuzzi is necessary for the success of your firm, but the IRS is unlikely to agree unless you are a Jacuzzi-selling company.
You may find a comprehensive list of simple and sophisticated deductions in our business cost guide.
Accounting and Bookkeeping for LLCs
It is critical to ensure that your records are in order in order to safeguard your corporate veil.
Separate your personal and work costs as much as feasible. You may do this by:
Establishing a separate business bank account
Getting a business credit card for company spending.
Developing a reliable accounting system – A good accounting tool may help you keep track of your spending and make the process straightforward and painless. You might also employ an accountant.