The primary benefit of organizing your business as a Limited Liability Company (LLC) is that the owners are protected from personal liability if the business is sued. The only other entity that has this same level of protection is a corporation. There are several ways to treat LLC taxes, which can make things a bit confusing.
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4 Ways An LLC Can Be Treated For Tax Purposes
The IRS allows LLCs to be taxed in four different ways:
- Sole proprietorship (for single-member LLCs)
- Partnership (for multi-member LLCs)
- S Corporation (single-member or multi-member LLCs)
- C Corporation (single-member or multi-member LLCs)
Since an LLC is not considered a taxable entity by the IRS, most LLCs are taxed on their personal tax return. The default tax treatment for a single-member LLC is as a sole proprietorship. The default tax treatment for a multi-member LLC is as a partnership.
As an LLC, you don’t have to accept the default tax treatment. Instead, you can elect to be treated as a C corp or an S corp. Below, you will find a brief description of each of these types along with their federal tax reporting requirements.
1. Sole Proprietorship (Default tax treatment for single-member LLCs)
For tax purposes, a single-member LLC is by default treated like a sole proprietor. All business income, deductions, and credits must be reported on Schedule C, which will carry over to the owner’s personal tax return. In addition, the owner must also pay self employment tax on their net earnings. We will discuss filing details in the Tax Filing requirements for a single-member LLC section of this article.
2. Partnership (Default tax treatment for multi-member LLCs)
For tax purposes, a multi-member LLC is by default treated like a partnership. All income, deductions, and credits of the partnership must be reported on Form 1065 and pass through to the partner’s personal tax return. Similar to the single-member LLC, each partner is responsible for paying self-employment tax on their net earnings. To learn more, read the Tax Filing requirements for a multi-member LLC section of this article.
3. S Corporation
As we mentioned above, an LLC can elect to be treated like an S Corporation for tax purposes. To elect S corp status for an LLC, you need to file Form 2553. For info on how to qualify for S corp status and file Form 2553, check out this article.
An S Corp is treated like a partnership for tax purposes. All income, deductions, and credits of the S Corp are passed through to the owners on Schedule K-1. To learn more, read the Tax Filing requirements for an S Corp section of this article.
4. C Corporation
An LLC can also choose to be treated like a C Corporation for tax purposes. By making this election, the business will be recognized as a separate and legal entity for tax purposes. This means that all business earnings would be taxable to the corporation and not passed onto the owner’s personal returns. To elect C corp status for an LLC, you need to file Form 8832. To learn more, read the Tax Filing Requirements for a C Corp section of this article.
Below we have summarized the tax forms that you need to file based on how you choose to have your LLC taxed.
LLC Tax Returns Required for a Single-Member LLC (Sole Proprietorship)
A single-member LLC that is taxed as a sole proprietorship is required to complete & file both of the following tax forms along with their personal 1040 tax return:
Schedule C (Profit or Loss from a Business) – Schedule C is the tax form used by sole proprietorships to report all income and expenses for a business. For step by step instructions for schedule c, check out our how to complete schedule C guide.
Schedule SE (Supplemental Income or Loss) – Schedule SE must be filed by a single-member LLC that chooses to be treated like a sole proprietor for tax purposes. This schedule is for reporting self employment income. Net earnings of $400 or more must be reported on Schedule SE and filed with your personal tax return. To learn more about self employment tax rates and how to lower your tax bill, check out our guide.
LLC Tax Returns Required for a Multi-Member LLC (Partnership)
Multi-member LLCs that are taxed as partnerships are generally required to complete & file the following three tax forms:
Form 1065 (U.S. Return of Partnership Income) – Partnerships are required to report all income, deductions and credits of the partnership on Form 1065. This form is filed for informational purposes only which means that there is no tax due. As mentioned previously, taxes are paid at the partner level based on their share of income, deductions and credits reported on Schedule K-1(Form 1065). For more info on how to complete Form 1065, check out our How Do I Complete Form 1065? guide.
Schedule K-1 (Partner’s Share of Income, Deductions, and Credits) – Since partnerships do not pay taxes as an entity, the income and expenses generated by the partnership must be paid by each partner. Each partner’s share of the partnership’s income and expenses is provided on Schedule K-1. Each partner must report this information on his/her personal tax return using Schedule E.
Schedule SE (Self-Employment Tax) – Each member of a multi-member LLC that is taxed as a partnership is subject to self-employment tax on net earnings of $400 or more. To calculate self-employment tax, complete Schedule SE and file it with your personal tax return. To learn all about self employment tax rates and who has to pay, check out our guide.
LLC Tax Returns Required for an LLC that Elects to be Taxed like an S Corp
An LLC that elects to be treated like an S corp for tax purposes is required to complete and file the following tax forms:
Form 1120S (U.S. Income Tax Return for an S Corporation) – Form 1120S is used to report all business earnings for an S Corporation. An S corp is not considered a taxable entity, which means all income and expenses generated by the business must be reported on Form 1120S and passed through to the members of the LLC on Schedule K-1 (Form 1120S) to be reported on their personal tax returns.
Schedule K-1 (Shareholder’s Share of Income, Deductions & Credits) – Since S corps do not pay income taxes as an entity, the income and expenses generated by the S corp must be paid by each shareholder. Each shareholder’s share of income and expenses is provided on Schedule K-1 (Form 1120S). Each shareholder must report this information on his/her personal tax return using Schedule E.
LLC Tax Returns Required for an LLC that Elects to be Taxed like a C Corp
An LLC that has made the election to be treated like a C corp for tax purposes is required to complete & file the following tax form:
Form 1120 (U.S. Corporate Income Tax Return) – Form 1120 is used to report all business earnings for a C Corporation. Since a C Corporation is viewed as a taxable entity by the IRS, all income and expenses generated by the business must be paid by the business.
Choosing Your LLC Tax Treatment: Pros & Cons
There are a number of factors to consider when making the decision to be treated as a Sole proprietor, Partnerships, an S corp or a C corp for tax purposes. Each business structure is unique, and the tax laws change quite often. Therefore, you should seek the advice of a CPA or tax attorney who can evaluate your business and help you make this decision.
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Consider the following when electing how you want your LLC to be treated for tax purposes:
No Double Taxation for Sole Proprietors, Partnerships, & S Corps
Sole proprietors, partnerships and S corps do not have the “double taxation” issue that C corps have. All income and expenses are passed through to the owners of these 3 entities and taxed once. However, when it comes to a C corp, all profits are taxed at the corporate level and then again when profits are distributed to each shareholder in the form of dividends. This is called double taxation.
Treatment of S Corp and C Corp Owners as Employees
The owners of an LLC taxed as an S corp can also be treated as employees of the company and draw a salary. This is a benefit to the owners if the LLC is profitable and they have high social security and medicare taxes. The employer portion of social security and medicare tax (also known as FICA) will reduce the amount of net earnings that will pass through to the owners, resulting in a lower tax bill.
While owners of a C corp who are involved in the day to day business can draw a salary as well, the owners will not benefit from a reduction in FICA since the corporation (not the owners) will pay taxes on the net earnings of the company. To learn more about FICA, click here.
Treatment of Operating Losses
If an LLC taxed as a sole proprietor, partnership, or S corp reports a loss, this loss will pass through to the owner’s personal tax return, which can result in a lower tax bill. In contrast, a loss for an LLC taxed as a C corp will just carry forward and offset future earnings of the company.
Lower Tax Bill
The overall tax bill for an LLC taxed as a sole prop, partnership, or S corp could be lower than a C corp since the taxes for these 3 entities are based on the individual tax rate of the owner as opposed to a corporate tax rate like the C corp is.
No Self Employment Tax for a C Corp or an S Corp
One major benefit of an LLC taxed as a C Corp is that a C Corp is a taxable entity. This means that all income, deductions, and credits generated by the company are paid and reported by the corporation. However, sole props and partnerships are not considered taxable entities. Therefore, net earnings pass through to the individual owner’s personal tax returns which requires self employment taxes to be paid on those earnings.
Other Obligations for LLC Taxes
In this article, we have focused on federal income tax requirements for an LLC. However, you may be subject to additional taxes.
In most states, LLCs also have to pay state income taxes. If you live in one of the 7 states that does not have a state income tax (Alaska, Florida, Nevada, S. Dakota, Texas, Washington, Wyoming), then lucky you! For those not so fortunate, you will report and pay taxes for your LLC to your state just like you do federal taxes.
If you sell products that are taxable, then you must collect sales tax from your customers and report and pay that tax to the state authorities. To learn more about state and local tax requirements, check your state tax agency website.
Some states charge an annual LLC fee known as a franchise tax, registration fee, or renewal fee. Be sure to do your research on what taxes an LLC is required to pay in your state and find out what additional fees an LLC is required to pay.
The Bottom Line
As a business owner, it is important for you to understand what your tax obligations are at the federal, state, and local levels. Now that you know how federal income LLC taxes work, I recommend that you use an accounting software like QuickBooks to allow you to stay organized and be prepared for tax season. Click here for a free 30 day trial.