How LLCs Get Taxed; Choosing a Tax Structure for Your LLC

Unlike a corporation (like a C-Corp or S-Corp) a Limited Liability Company is not a separate taxable entity. The IRS refers to LLCs as “pass-through entities,” which means simply that you and your co-owners will be taxed personally.  

In fact, this is a lot like the way in which sole proprietorships or partnerships are taxed. But LLCs, as we’ve mentioned before, are by nature flexible. You can actually choose to be taxed in the way a corporation would by filing a form with the IRS.

Let’s talk about the default way your LLC will be taxed, how your LLC Operating Agreement can give you further control, what forms you should file, and lastly, how to change your tax identity if you so choose.

How Your LLC Will be Taxed

As we mentioned above, an LLC defaults to a “pass-through entity.” This means if your LLC makes $20,000 profit, you’re paying the taxes on your share of that profit on your personal tax return. So, say your LLC has four partners with an equal share of the company. You’ll each pay the taxes on $5,000 profit. If your LLC is yours and yours alone, you’ll pay the taxes on your profit on your 1040 tax return.

What Forms You Should File

Every LLC should have an Operating Agreement and you can read more about that here. Operating Agreements don’t need to be filed in most states, but if you want to work out a profit split that could directly influence what each owner will pay on their individual taxes, you can sort out those arrangements in your operating agreement.

Past that, you’ll need to file Form 1065 with the IRS. The IRS uses this to ensure each LLC member is properly reporting their income from the LLC. You should also give each member a Schedule K-1 so everyone has, in writing, their share of the profits and losses.

After this, every member of the LLC will be taxed personally on their 1040 tax return.

How to Change Your Tax Identity

Some LLCs elect to be taxed as corporations (like a C-Corp or S-Corp). But why? The most common reason is that their business wants to keep a hefty amount of their profits in their LLC and these so-called “retained earnings” are generally taxed at a lower rate than they would be on a personal 1040 tax return.

To elect corporate taxation, you’ll have to file IRS Form 8832. On it, there should be a section in which you can elect to be taxed as a corporation.

Additional Information

Here are a few more items you might want to keep in mind.

• Since LLC members aren’t technically employees, and since you’ll be taking these earnings out of your personal tax return, don’t forget to set some profits aside come tax time.
• Likewise, your Social Security taxes and Medicare taxes won’t be taken out on a paycheck to paycheck basis.
• Last of all, please remember that LLC laws in each state are different. Some states will in fact tax your LLC in different manners. Consult with an experienced business attorney or accountant for the rules in your locality.

 

Laws on this topic may vary from state to state. This content is not meant to provide you with complete information and it is not intended to be legal or tax advice. It is recommended that you consult with your own attorney, accountant or other advisor regarding your specific situation.