How Do Limited Liability Companies (LLCs) Pay Taxes?

When choosing a business entity for your company, considering taxes is paramount. Ultimately, the entity you choose — such as a limited liability company (LLC), sole proprietorship, or corporation — impacts how much your business owes the government in taxes, as well as the filing process. LLCs, a type of business that is registered with the state and provides personal liability protection for owners, can choose how they want to be taxed.

How do LLC taxes work?

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. Instead, the LLC owners, known as members, pay taxes on their share of the LLC’s profits. However, members can choose for the LLC to be taxed as a corporation instead of a pass-through entity.

There are several types of LLC taxes. The federal government, as well as state and local governments, levy these taxes. All LLC members are responsible for paying income tax on any income they earn from the LLC as well as 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.

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How LLCs pay income taxes

LLC owners can be responsible for a wide range of business taxes, but federal, state and local income taxes represent the biggest burden. 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).

Income taxes for single-member LLCs

By default, the IRS treats a single-member LLC as a disregarded entity for federal income tax purposes. This means LLC members report the business’s profit and loss on their individual tax returns instead of filing a separate business form.

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. 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, and 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 income. Take these LLC taxes into account when selecting your business structure and making budgeting decisions.

Income taxes for multi-member LLCs

Similar to the single-member LLC, multi-member LLCs are typically treated as pass-through entities for federal income tax purposes, meaning the LLC doesn’t pay taxes of its own. Instead, each member pays taxes on the LLC’s income in proportion to their ownership stake. The LLC tax rate aligns 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 small-business 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, and some may charge additional LLC taxes.

Choosing corporate tax status for your LLC

LLC members can choose for the business to be classified as a C corporation or S corporation, rather than a pass-through entity, 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, with some differences in how salary and distributions from the business are taxed. To file taxes for an S-corp, submit Form 1120-S, 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.

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LLC payroll taxes

LLCs with employees have to collect and pay payroll taxes, which include unemployment, Social Security, 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 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.

LLC self-employment taxes

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 three parts:

• 12.4% Social Security tax on earnings up to $168,600.

• 2.9% Medicare tax on all earnings.

• 0.9% Medicare surtax on earnings over $200,000.

Schedule SE will help you calculate your tax liability and should be attached to your tax return.

LLC sales taxes

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 goods or service. Contact the departments of revenue in the areas where you sell to check the rules that apply to your business.

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LLC tax forms and deadlines

The exact tax forms you’ll need to complete your LLC taxes depend on three things:

1. Whether your LLC is single-member or multi-member.

2. Whether you choose default (pass-through) tax status or corporate tax status for your LLC.

3. Whether your LLC has employees.

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. 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.

LLC tax tips for business owners

Here are some tips to help lower your tax burden and making filing easier:

• Take advantage of any tax deductions and tax credits that your LLC is eligible for.

• Review business tax deadlines in advance, and note relevant due dates.

• Hire a certified public accountant (CPA) or tax professional to assist you with tax filing.

• Talk with your CPA or tax professional about the potential benefits of electing corporation tax status for your LLC.

• Understand tax requirements for your state and locality.

» MORE: A comprehensive list of IRS business forms