LLCs are flexible when it comes to determining how you want to be taxed. You can choose to have your LLC taxed like a sole proprietorship, partnership, or corporation by filing the appropriate forms 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.
If I Do Nothing, How Will My LLC Be Taxed?
The IRS automatically classifies your LLC as either a sole proprietorship or a partnership, depending on how many members (owners) the LLC has.
- If you are the only member, your LLC is treated as a sole proprietorship.
- If there is more than one member, the IRS treats your LLC as a partnership.
As a pass-through entity, your LLC’s profits and losses flow directly to your personal income tax return.
For example, if your LLC earns $20,000 in profit and has four equal partners, each partner reports $5,000 of income on their personal tax return. If you are the sole member, you report the entire $20,000 on your Form 1040 using Schedule C.
What Forms Should I File?
Every LLC should have an Operating Agreement, even if your state doesn’t require one. This document outlines the structure of the business, including—when applicable—details related to taxation and profit distribution. Be sure to check if your state requires you to file your operating agreement.
If your LLC has more than one member, the business must file Form 1065 (U.S. Return of Partnership Income) with the IRS. This form ensures that each LLC member properly reports their share of income or loss.
After this, every member of the LLC will be taxed personally on their 1040 tax return.
How Can I Change My LLC Tax Identity?
Some LLCs elect to be taxed as corporations (C-Corp or S-Corp). The most common reason to do this is to retain profits in the business that would otherwise be taxed at personal income tax rates.
To elect corporate taxation, you’ll need to file IRS Form 8832 (Entity Classification Election). On this form, you can elect to be taxed as a corporation.
If you want to be taxed as an S corporation, you’ll also need to file IRS Form 2553 (Election by a Small Business Corporation).
What Else Do I Need to Know?
Here are a few more items you might want to keep in mind.
- Since LLC members aren't technically employees, and since you may be taking these earnings out of your personal tax return, remember to set some profits aside come tax time.
- Likewise, your Social Security taxes and Medicare taxes may not be taken out on a paycheck to paycheck basis.
- Last of all, please remember that LLC laws in each state are different. Some states may tax your LLC in different manners. Consult with an experienced business attorney or accountant for the rules in your locality.
Please note: This page offers general legal information, not but not legal advice tailored for your specific legal situation. Rocket Lawyer Incorporated isn't a law firm or a substitute for one. For further information on this topic, you can Ask a Legal Pro.
