An LLC is a type of business structure in the US which protects its owner/s from being responsible for company debts or other liabilities. The IRS will treat an LLC as either a corporation, partnership or a disregarded entity depending on the number of members within the LLC. This means that LLC taxes will differ for a single member LLC or a multi member LLC. An LLC is not subject to federal income tax, however some States may tax the LLC itself. There are four federal tax structures available for an LLC namely:
- Single-member (Disregarded Entity)
- Multiple-member (Partnership)
An LLC is created by state statute therefore it has some flexibility, but which option is the right one for you? This article will outline the different tax classifications.
A single member LLC also is treated the same as a single owner business or a sole proprietor. The business is owned by only one owner and falls within the “pass through” taxation category. As with a sole proprietor, the single member LLC includes its profits and losses from Schedule C with the owners personal tax return.
Self-employment taxes are only required for LLC’s who provide a service or are selling goods. When an LLC’s activities are passive for example a real estate investment company, then it is not required to pay self-employment taxes on the profits. This will be reported on a Schedule E form.
An LLC with multiple owners (members), is treated like a partnership and needs to show all profits or losses on Form 1065 (Schedule K-1) partnership tax returns. Each owner (member) is required to complete tax form Schedule K-1 indicating their portion of the LLC’s profit or loss. The Schedule K-1 form is included in the owner’s personal income tax return and each owner pays self-employment taxes on their share of the profit.
An LLC can choose to be treated as a corporation by the IRS. The LLC must file a corporate tax return and must then pay taxes on its profits on their corporate tax rate. If the LLC chooses to distribute its profits to members in the form of dividends, those dividends will be taxed again at the appropriate rate. This is also known as double taxation.
The profits of the LLC are not subject to self-employment tax, but the LLC is responsible for taxes on any salaries paid to members. The C-Corporation is a good option if the LLC plans to keep the profits within the business and not distribute it to its members. Then only the corporation is taxed on the profits and owners are not responsible for paying taxes on any money that remains within the business.
In this last option an LLC can decide to be treated as an S-Corporation by filing an 1120S tax return. As an S-Corporation, the companies profits are not subject to corporate tax as with a C-Corporation. The members (owners) of the corporation are taxed separately on their respective share of the profits earned and the profits are not subject to self-employment taxes.
Owners that are employed by the corporation and perform work, must be paid a salary that is reasonable and the corporation will then have to pay taxes on the employee wages.
It is however important to remember that there are certain limitations that comes with an S-Structure such as:
- An S-Corporation is not permitted to have more than one class of stock.
- The corporation cannot have more than 100 stockholders
- Only US citizens or residents can be stockholders (some exceptions do apply)
- An S-Corporation election is required by filing form 2553 with the IRS. This must be done no later than two months and 15 days after the start of the tax year.
The Right Choice for you.
All of the above options have their pros and cons so it is important to know the structure of the LLC and how it will operate before making a decision on which taxation structure should be chosen. All businesses have unique circumstances and business needs. Investigate and research all the options thoroughly to ensure the correct decision is made for the particular LLC in question