Since an LLC is formed at the state level, it is not a business classification for the IRS. This means that you can choose how your business is classified by the IRS: sole proprietorship (one owner), partnership (two owners) or corporation (any number of owners).
In this article, we will discuss the basics of filing taxes for these three classifications. But first, let’s talk about how LLCs file taxes, because it is different than the way other business classifications file.
The first thing to understand about how an LLC files taxes is that LLCs are considered “pass-through” entities by the IRS. This means that the business’s profits and losses “pass through” to the partners. Because of this, the LLC itself doesn’t pay federal taxes. The partners will report profits and losses on their personal tax return. (In other words, tax liability “passes through” to the partners.)
A question we get from a lot of LLC members is whether they owe self-employment tax on their share of the company’s profits. Generally, yes, members who are actively engaged in the business must pay self-employment tax. If you have any questions about whether you owe self-employment tax, or how to calculate and pay your share, please contact your accountant.
If you are the only member of your LLC, you’ll file as a sole proprietorship using Schedule C (Form 1040).
To file a Schedule C, you’ll need the following information:
You’ll use this information to file your Schedule C on your personal tax return.
In the eyes of the IRS, LLCs with more than one member are partnerships for tax purposes. This means the LLC doesn’t pay tax, but taxable profits and deductible losses are passed on to the members/partners according to tax rules.
At tax time, the LLC will file Form 1065: Partnership Return of Income. This form should also include a Schedule K-1 for each member. The Schedule K-1 reports each partner’s share of income, deduction, and tax credit items related to the LLC. These totals will then be included on each partner’s personal tax return.
If you and your business partners choose to file taxes as a corporation, you will tell the IRS ahead of time by filing Form 8832: Entity Classification Election. Then, at tax time, you’ll use Form 1120: Corporation Income Tax Return, or the short form, 1120-A.
Filing LLC taxes as a corporation can actually save you and your business partners money. As of 2018, all regular “C” corporations are taxed at a flat 21% rate on all their profits. This is a lower rate than the top three individual income tax rates (32%-37%) that would apply to LLC owners at various income levels.
Although this sounds ideal, keep in mind that money distributed from a C corporation to its owners may be doubly taxed: first the 21% corporate tax and then the shareholders individual income tax on their dividends at capital gains rates, which range up to 23.8%. But retained earnings, the amount of net income left over after the business has paid out dividends to its shareholders, cannot be taxed twice.
We offer a broad range of business law services and representation for individuals and companies, big and small, such as business entity formation and contract related issues. Contact The Doyle Law Offices at (919) 228-4487 or fill out the form below.