When determining which business entity a company should be registered as, taxes are one of the biggest considerations. The type of entity a business is registered as will determine how much a company is required to pay in yearly taxes. The team at Evolution Tax and Legal is breaking down the tax structure for an LLC, or a limited-liability company, which is a business entity that provides personal liability protection to its owners.
How Are LLCs Taxed?
For tax purposes, an LLC is treated as a pass-through entity, so the business is not taxed on income itself, but the owners and shareholders are taxed based on their share of the profits. Members are able to choose for an LLC to be taxed as a corporation.
There are several different types of LLC taxes that owners must pay, which are levied by federal, state and local government and may change depending on the state or town which the LLC is registered in. LLC owners are required to pay taxes on their share of the LLC’s profits, as well as self-employment taxes. If the LLC employs individuals, LLC owners can also be required to pay payroll taxes and sales taxes.
How LLCs Pay Income Taxes
Income taxes for LLCs are filed and paid differently depending on whether it is a single or multiple-member LLC, or whether the LLC has one owner or multiple owners.
Income Taxes for Single-Member LLCs
For an LLC that has one owner, the IRS treats the LLC as a disregarded entity for federal income tax purposes. This means that the LLC is not required to file a separate income tax form to report earnings, and any income and expenses will go directly on the single member’s yearly tax return. Each year, the owner must file the LLCs earnings on Form 1040, Schedule C. This is similar to the return a sole proprietor must file during their yearly tax return. When filing the return, after deducting business expenses, if the LLC generates a profit, the member must pay taxes on the profit in accordance with their personal tax rate. If the LLC is operating at a loss, they can deduct the losses from their income taxes for that tax year.
This process generally follows a similar structure on a federal, state and local tax level. Any income or profit will be taxed from the individual at their federal, state and local personal income tax rate. Only income which is earned within the state or local municipality will apply to the taxed income for the individual. Some states charge an extra fee for LLC members, for example California which charges an annual fee of $800 to owners of an LLC within the state.
Income Taxes for Multiple-Member LLCs
Multiple-member LLCs, or LLCs with multiple owners, are treated as a pass through entity for federal income tax purposes. This means that the LLC does not pay income taxes as a business, but each member must file their taxes including their stake in the LLC on their tax returns and they must pay for any income made based on their individual income tax rate. For example, if an LLC has two owners who each have a 50% stake in the company, both owners will pay taxes on 50% of the LLC’s profits for the tax year. Each owner is able to claim half the deductions for any losses, and account for half the business expenses. This system is taxed similarly to a business partnership.
A multi-member LLC must file additional forms with the IRS each year, including informational returns, Form 1065 and Schedule K-1, which summarizes each owner’s share of income, losses, credits and deductions within the LLC. This schedule must be filed for each owner, and attached to their personal tax return each year. The pass-through taxation system continues at the state and local level.
Choosing Corporate Tax Status for Your LLC
Members of an LLC can make the decision to choose C-corporation or S-corporation status for their LLC, for tax purposes, if they decide this is best for their business. If an LLC chooses to be taxed as a C-corporation, they are required to file Form 8832 with the IRS, and potentially additional informational forms with the state to establish this tax status. Being taxed as a C-corporation means the LLC will face the 21% corporate tax rate on all business income, and the business must file tax Form 1120, which is the U.S Corporation Income Tax Return.
If an LLC chooses to be taxed as an S-corporation, an LLC must file Form 2553 with the IRS. S-corporations are taxed as pass-through entities, which is similar to an LLC, although there are differences to how salary and business distributions are taxed. Form 1120S, the U.S Income Tax Return for an S-Corporation is to be filed by any LLC who has been classified as an S-Corporation for tax purposes. From a legal standpoint, changing the tax status of your LLC will make no difference. Consulting with a tax professional about your personal situation within your LLC is the best way to determine if you can benefit from choosing a corporate tax status.
LLC Payroll Taxes
As mentioned above, LLCs that have employees must collect and pay payroll taxes, which includes Social Security taxes, Medicare taxes and unemployment taxes. Employers must withhold their employees’ share of these taxes from their paycheck, in addition to paying into these taxes as an employer. Payroll taxes are filed using Forms 940, which is filed annually, and 941, which is filed quarterly. These forms determine the employer and employee’s portion of social security and Medicare taxes that must be withheld.
The IRS uses a pay-as-you-go system for payroll taxes, which means these taxes will need to be deposited throughout the year according to a schedule set by the IRS. Unemployment taxes are deposited quarterly, while social security and Medicare taxes are deposited either monthly or bi-weekly, depending on the amount of the LLC’s tax liability. Along with federal payroll taxes, state and local governments typically have their own payroll taxes that your LLC must be aware of. Due to the complicated nature and year-round attentiveness of payroll taxes for your LLC, it is beneficial to speak with a seasoned tax professional to determine the best course of action for filing and paying your business’ payroll taxes.
LLC Self-Employment Taxes
While members of an LLC are not considered employees, under the Self Employment Contributions Act, they are still responsible for contribution to social security and Medicare. As such, members must file self employment taxes each year, which will be paid directly to the IRS annually. The total self-employment tax percentage is 15.3%, which is broken down into 12.4% into social security tax, 2.9% in Medicare tax and .9% in Medicare surtax on any earnings over $200,000. Schedule SE will help you determine your tax liability as a self-employed individual, and must be attached to your yearly tax return.
LLC Sales Taxes
If your LLC sells goods or services, you’ll be required to collect sales tax and submit the funds to state or local government, in accordance with their state and local tax percentage on goods and services. Which goods and services are taxable depends on the state and town in which you live, and some states do not charge state sales tax at all. Whether or not you have to collect sales tax depends on your connection, or ‘nexus’ with the area in which goods or services are being sold. A connection that is great enough to require sales tax collection includes employing locals in the area, having a storefront in the area or shipping goods to the area. Most states follow destination-based rules, meaning sales tax must be charged based on the final destination of a product. This means that even online businesses are liable to charge sales tax, if they are shipping products to a destination where sales tax is collected.
LLC State Income Taxes
Members of LLCs are responsible for filing state income tax returns, in addition to federal returns. Most states follow a similar tax structure for LLCs to the federal structure, in that members can pay taxes on an LLC’s profits through their personal tax returns. A few states require additional taxes be paid on the income made through an LLC.
LLC Tax Questions? Evolution Tax and Legal Can Help
Discussing the benefits and flexibility of registering and being taxed as an LLC with a seasoned business formation lawyer can help you determine the best course of action, whether you are deciding how to register your business or determining the tax status of your LLC. Contact the team at Evolution Tax and Legal with your LLC tax questions today.