Are you thinking about starting an LLC?
It’s one of the most popular legal entities and has a lot of perks. But like any other type of business, it comes with some responsibilities too.
In this article, we at HostingTribunal will tell you everything you need to know about LLC taxes:
Why are they considered to be so flexible?
How are they calculated?
What does a pass-through entity mean?
What should you know about LLC tax filing?
Read on to find out!
LLC Income Taxes
Taxes are what the government takes from a worker’s income or a company’s profit. However, one of the main LLC tax benefits is that the business isn’t considered a separate tax entity.
For that reason, the LLC federal tax isn’t charged on the company’s profits. Instead, the money counts toward your personal income as a sole proprietor or co-owner of the business.
Single Vs. Multi-Owner LLCs
If there is only one owner, the LLC is taxed as a sole proprietorship. Sole proprietors report all profits or losses on Schedule C and submit the information with their 1040 tax return.
A multi-owner LLC is taxed as a partnership. Each member has a distributive share of the profits described in the operating agreement. They have to pay taxes on their whole share whether they received the money or not.
What happens if you leave profits in your company’s bank account?
You might want to cover expenses or pay out New Year’s bonuses to your employees. LLC members will still pay taxes on their portion of the income—even if they never saw a cent of it.
What about LLC partnership taxes?
Multi-owner LLCs also have to file Form 1065, which helps the IRS confirm that the income is reported correctly. The company also provides members with Schedule K-1, confirming their share of the profits and losses.
Then, much like single-member LLC taxes, owners file their own 1040 tax returns with the Schedule E attachment.
Most LLC owners also pay “self-employment taxes” to contribute to the Social Security and Medicare systems.
As an owner, you’re paying LLC taxes on your portion of the business income. Your share usually depends on the percentage interest you have in the company. For example, if you own 50% of the business, you will get 50% of the profit.
However, LLCs are free to choose another way to divide profits. This is called special allocation and it’s one of the many advantages of LLC formations.
For instance, let’s say you invest 100% of the money necessary to start the business, but you’re working with an essential partner. You and your partner each have 50% of the company. However, since you contributed all the capital, your operating agreement might state you get 75% of the profits.
The IRS says special allocations must have a “substantial economic effect.” You can’t use them to reap additional LLC taxation benefits, but you can set them up to reflect who “deserves” what portion of the profit.
LLC Owners and Self-Employment Tax
Taxes for LLC members also include their contribution to the social and medical systems. Any non-corporation business owner or self-employed professional pays:
- 15.3% up to a yearly threshold
- 2.9% of net income over the threshold
If you don’t actively work or manage the LLC (e.g., you only invested money initially), you might be exempt from self-employment tax. If you aren’t, you submit the amount due on Schedule SE and file it with your tax return.
The self-employment taxes go with the rest of the money you owe on the 1040 form.
What Is a Pass-through Entity?
LLCs are pass-through entities because the profits “pass through” the company’s earnings to your own 1040 tax return.
This is another huge LLC benefit since it prevents double taxation. Corporation shareholders, for example, pay taxes twice:
First, the government takes a portion of the company profits through income tax. Then, as a shareholder, you receive some money and you’re taxed for it on your personal tax form.
LLC taxation rates only affect your income once—after the profits pass through to your own return.
Paying LLC Taxes as a Corporation
Even though LLCs are usually treated as sole proprietorships or partnerships, you can choose to be taxed as a corporation.
To do this, you first file the IRS Form 8832, Entity Classification Election, which tells tax authorities you’re switching to corporate LLC tax treatment.
As a regular C corporation, you’ll be taxed a flat 21% rate on your income, which is lower than most individual tax rates. If your company is making a substantial profit, choosing corporate taxation can save you tax dollars.
However, you will also experience LLC double taxation. First, you pay the 21% income tax; then, you and each of the other members pay tax on your own profits.
But owners won’t be taxed on retained earnings.
Remember how most LLC owners pay taxes on their whole profit share? And if money were left over in the company bank account at the end of the fiscal year, you’d still owe taxes for them.
This doesn’t happen with LLCs that are taxed as corporations, erasing one of the main disadvantages of LLC taxation.
Additionally, you can also offer employee and owners fringe benefits, stock options, and ownership plans, which are free from double taxation.
How Is LLC Taxation Calculated?
LLCs don’t pay taxes; their owners do. So any profit share you get is taxed based on your tax bracket and whether or not you’re filing jointly with your spouse.
However, your taxable income isn’t the same as your total income.
As a business owner, you’re eligible for a variety of deductions and write-offs. For instance, you’re not expected to pay LLC taxes on any of your business expenses—equipment costs, company cars, marketing, and promotion, etc.
Under the 2018 tax reform bill, all companies can also deduct 20% of their profits from their taxable income. You can also get a tax deduction for home office work, write off the interest on your business loan, and even get a tax deduction.
That’s right; since LLC and personal taxes go hand in hand, you’re allowed to deduct up to $10,000 of your self-employment tax. This also applies to any state and local income taxes, such as:
- Real estate
- Personal property
- … and more!
Once you calculate your taxable income, you can figure out how much you owe during your LLC tax filing.
State Taxes and Fees
Do you want to know how to file taxes for LLC? You don’t have to. Unless you’re taxed as a corporation, the profits go straight to your personal income.
But there is a catch:
LLCs are in an advantaged legal position. On the one hand, they benefit from pass-through taxation, just like sole proprietorships and partnerships.
On the other, LLC owners enjoy limited liability for company debt, just like corporations do.
Most states ask you to pay annual taxes or fees for the opportunity to be in this rather beneficial position. These are different from one-time LLC registration fees and while most of them are billed yearly, there are also biennial charges.
The amount you owe will vary significantly between states—in some cases, it might even be $0. For instance, Ohio doesn’t have LLC annual fees, while in California, you’ll be paying $800 + $20.
Does this mean you should register an LLC wherever the fees are the lowest?
You apply for an LLC in your home state – or use a professional service to help you out – where you’ll be doing business. Online businesses also count. Registering in another state could mean you’ll end up operating illegally in your own.
The only exception is for non-residents who can create an LLC in any state they choose.
To learn how to create an LLC, check out our dedicated guide.
LLC Tax Benefits
Tax flexibility and pass-through taxation are some of the key benefits of having an LLC.
Other LLC tax return perks include:
- Choose your own profit allocation model. You can distribute the income based on stake or use a special allocation, as long as it reflects a genuine economic impact.
- There is no LLC tax form; you only pay for the profit allocated to you as an owner.
- You don’t experience double taxation of your income since LLCs are pass-through entities.
- You can choose corporate LLC taxing and be treated as a corporation by the IRS. It’s a great way to save money if you’re making a larger profit.
- There are very few LLC forms you have to fill in. You’re not doing taxes for an LLC; you’re just doing your own tax return.
With multiple LLC tax benefits, plus all the additional advantages, it’s no wonder LLCs are one of the most common legal structures. LLC taxes pass-through from your company’s income to your personal tax return, so you’re only paying taxes once.
There is no tax filing or a tax form for LLC businesses unless you choose corporate treatment. If that’s the case, you’re paying the flat 21% corporate tax and you might end up saving money, especially if your company’s income is higher.
Otherwise, your LLC taxes will only depend on what tax bracket you fall into.
Yes, it absolutely does.
LLC taxes are flexible and if you choose to be taxed as a sole proprietor/partnership, you avoid double taxation. An LLC is a simple and money-saving legal structure for your business.
The IRS treats your LLC as a pass-through entity. This means the company itself doesn’t pay taxes. Instead, the profit goes straight into the owners’ bank accounts—and they pay personal income tax on it.
If you didn’t make a profit AND you don’t have business expenses, you don’t even have to file a tax return. If you have expenses but no profit, you can file a loss on your business.
Sole proprietors will do this on Schedule C of their tax return. Partnerships, on the other hand, still have to file an informational tax return Form 1065 even if it’s just to stay safe and avoid the late filing fee.
To reduce the tax for your LLC, make sure you’re taking advantage of tax deductions and write-offs. Subtract all of your business expenses from your annual income—even those you might not think about initially (e.g., client dinners).
Deduct your self-employment tax and look into home office deductions and additional small business deductions you can use.
You can calculate your LLC taxes by figuring out your taxable income (do take advantage of tax deductions) and checking what tax bracket you fall into. Saving 30% of your business income is a good rule of thumb, although most businesses will end up paying less.