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An LLC is typically treated as a pass-through entity for federal income tax purposes. This means that the LLC itself doesn’t pay taxes on business income. The members of the LLC pay taxes on their share of the LLC’s profits. State or local governments might levy additional LLC taxes. Members can choose for the LLC to be taxed as a corporation instead of a pass-through entity.
When choosing a business entity for your company, taxes are paramount. The amount of taxes you’ll owe to the government is directly connected to your business entity structure. A limited liability company (LLC) is a type of business that is registered with the state and provides personal liability protection for owners.
There are several types of LLC taxes. The federal government, as well as state and local governments, levy these taxes. All LLCs are responsible for paying income taxes and self-employment taxes. Depending on what you sell and whether you employ anyone, you might also be responsible for paying payroll taxes and sales taxes. To complicate things even more, an LLC can opt to be taxed as a different business entity.
In this guide, we’ll cover the entire range of LLC taxes, what you’ll be responsible for, and options for reducing your tax bill. Understanding your tax burden in advance can help you make smarter financial decisions.
There’s a wide range of business taxes that the owners of an LLC might be responsible for. Federal, state, and local income taxes represent the biggest burden for most business owners. The way in which you file and pay income taxes depends on whether your LLC has one owner (a single-member LLC) or multiple owners (a multi-member LLC).
By default, the IRS treats a single-member LLC as a disregarded entity for federal income tax purposes. According to Vincent Porter, a Certified Public Accountant (CPA) at MyTexasCPA, “A disregarded entity means that the LLC is not required to file a separate income tax return to report income and expenses. The income and expenses will go directly on the member’s tax return.”
In other words, as the sole owner of an LLC, you’ll report business income and expenses on Form 1040, Schedule C, similar to a sole proprietor. If, after deducting business expenses, the LLC generates a profit for the year, the owner will owe taxes to the IRS in accordance with their personal income tax rate. For example, if you have $100,000 of net LLC income (and no income from other sources), and you fall into the 24% tax bracket, you’ll pay $24,000 in federal LLC taxes. If the LLC operates at a loss for the year, the owner can deduct the business’s losses from their personal income.
This process generally works the same way at the state and local level. For example, a single owner of a New York City LLC will report business income on their federal and state personal tax returns. The income will be taxed at the owner’s federal, state, and local personal income tax rate. The key is that you’ll only be taxed on income that’s attributable to the state or locality. According to Porter, “States will tax an LLC relative to the amount of sales, payroll, or assets that are owned in that state. In other words, if federal income is $100 and the company has $50 of payroll in New York and $200 of payroll everywhere, New York would tax $25 of the income to the state ($50/$200 x $100).”
Some states charge a separate LLC tax or fee. California, for example, charges an $800 annual LLC tax, plus an annual fee that varies based on your LLC’s California income. Take these LLC taxes into account when selecting your business structure and making budgeting decisions.
Multi-member LLCs are treated as pass-through entities for federal income tax purposes. Similar to the single-member LLC, this means that the LLC doesn’t pay taxes of its own. Instead, each member pays taxes on the business’s income in proportion to their ownership stake in the LLC. Thus, the LLC tax rate is in accordance with each member’s individual income tax bracket.
If, for instance, two members in an LLC have a 50-50 ownership split, each owner will be responsible for paying taxes on half of the business’s profits. Each owner can also claim half of the tax deductions and tax credits that the LLC is eligible for, and write off half of the losses. This type of taxation works almost exactly like a partnership.
A multi-member LLC has to file certain tax forms with the IRS, including Form 1065, U.S. Return of Partnership Income—an informational return that must be filed annually with the IRS. The LLC must also give each owner a completed Schedule K-1 by March 15 of each year. The Schedule K-1 summarizes each owner’s share of LLC income, losses, credits, and deductions. Each owner will attach their Schedule K-1 to their personal income tax return that’s filed with the IRS.
Pass-through taxation continues at the state and local levels. Most states have their own equivalent of Form 1065 and Schedule K-1. As mentioned above, a few states like California charge additional LLC taxes.
So far, we’ve discussed the default income tax rules for LLCs, but things can get more complicated. The members of an LLC can choose for the business to be classified as a C-corporation or S-corporation for tax purposes. The voting procedure and consent required to make this change will be reflected in the LLC operating agreement.
Your LLC can opt to be taxed as a C-corporation by filing Form 8832 with the IRS (your state might also require additional forms for a change in tax status). If you make this change, your LLC will be subject to the 21% federal corporate tax rate. You’ll need to file taxes using Form 1120, U.S. Corporation Income Tax Return. You’ll also pay state and local corporate taxes as applicable where your business is located.
To opt for S-corporation tax status, file Form 2553 with the IRS. An S-corp is taxed like a pass-through entity, similar to an LLC, with some differences in how salary and distributions from the business are taxed. To file taxes for an S-corp, submit Form 1120S, U.S. Income Tax Return for an S-corporation, to the IRS.
Note that choosing corporate tax status won’t affect your LLC from a legal standpoint. Legally, your business will continue to operate as an LLC. You should consult with a tax professional to see if you’d benefit from corporate tax status. Income in a corporation is taxed differently than an LLC, and a corporation is eligible for more deductions and credits.
LLCs that have employees have to collect and pay payroll taxes. These taxes include unemployment taxes, social security taxes, and Medicare taxes. Employers pay unemployment taxes to fund unemployment benefit programs. Employers and employees share in the payment of social security and Medicare taxes (collectively called FICA taxes under the Federal Insurance Contributions Act). Employers have to withhold the employee share of these taxes, along with income taxes, from their employees’ paychecks.
Payroll taxes are filed using IRS Form 940 and Form 941. Form 940 is filed annually and is used to report an employer’s unemployment tax obligations. Form 941 is filed on a quarterly basis. Businesses use this form to report withheld income taxes and the employer and employee’s portion of social security and Medicare taxes.
One thing to note is that these taxes aren’t paid when you file the tax forms. The IRS utilizes a pay-as-you-go system for payroll taxes, so you’ll need to deposit your payroll taxes throughout the year according to the schedule set by the IRS. Deposits can be made on the Electronic Federal Tax Payment System (EFTPS). Unemployment taxes are deposited quarterly, whereas social security and Medicare taxes are deposited either monthly or semiweekly depending on the amount of your tax liability. The IRS instructions for Form 940 and Form 941 can help you determine your deposit schedule.
For reference, here are the current federal tax rates for unemployment taxes, social security taxes, and Medicare taxes:
Along with federal payroll taxes, states and local governments often charge additional payroll taxes. For payroll taxes that are the employee’s responsibility, you’ll have to make the necessary withholdings and remit payment to the state or locality. You’ll pay employer taxes directly to the tax agency.
Members of an LLC are not considered employees. However, under the Self Employment Contributions Act (SECA), you still owe social security and Medicare taxes to the IRS. You’ll pay these taxes directly to the IRS in the form of self-employment taxes. The total self-employment tax is 15.3%, and it’s broken down into several parts:
To pay self-employment taxes, you will file your regular Form 1040 personal tax return and use Schedule C to calculate your self-employment income. Then, Schedule SE will help you calculate your tax liability and should be attached to your tax return.
If your LLC sells taxable goods or services, then you’ll need to collect sales tax from your customers and remit the tax to the state or local tax agency. Which goods and services are taxable depends on the state and locality where you do business. Forty-five states impose sales tax. Alaska does not levy a state sales tax, but several cities in Alaska charge local sales tax.
The legal test for whether you have to collect sales tax has to do with “nexus.” Sales tax nexus means that you have enough of a connection with a state or locality that you’re obligated to collect and remit sales tax there. The connection could be a physical shop in the area, employing people in the area, or shipping goods into the area. Online businesses could be responsible for collecting sales taxes in a state simply by virtue of the fact that they ship goods there.
Most states follow destination-based tax rules, which means that the sales tax rate is tied to the final delivery location of the product or service. A small number of states follow origin-based tax rules, in which case the sales tax rate is tied to the location of the business which sold the good or service. Contact the departments of revenue in the areas where you sell to check the rules that apply to your business.
The exact tax forms you’ll need to complete your LLC taxes depend on three things:
Here are the commonly used LLC tax forms and corresponding deadlines:
Note that if a tax deadline falls on a Saturday, Sunday, or federal holiday, you can file the document on the next business day. Also, if you request an extension for tax filing, you’ll get an additional six months to file. For example, tax filers who request an extension to file Form 1065 will have until September 15 to do so. Use Form 4868 to request an extension if you’re a single-member LLC taxed as a disregarded entity. In all other cases, use Form 7004 to request an extension on business tax filing.
It’s easy to feel overwhelmed by all the tax responsibilities an LLC might have. Fortunately, there are a few ways to lower your tax burden and make tax filing easier.
Here are some tips for LLC tax filing:
Porter says that understanding your LLC’s tax setup in the beginning is important. “Common mistakes are not engaging a CPA that is familiar with the tax rules surrounding LLCs. It’s much easier and cheaper in the long run to set up the LLC correctly the first time and make the valid elections for the LLC to be taxed as the business owner wishes.”
As you now know, there are several types of LLC taxes that you might be responsible for. With so many obligations to remember, it’s important to stay organized so that you file the correct forms and pay your LLC taxes at the correct time. If you need extra time to file your LLC taxes, request an extension so you don’t have to pay any penalties. With taxes taken care of, you’ll be able to focus on what matters most—running a stellar small business and making your customers happy!