If you have a limited liability company (LLC), whether a sole proprietorship or multi-member, you need to make sure taxes are handled properly. The prospect can seem daunting, especially if this is your first time, so we’re here to outline and clarify the process for you.
This article describes the different tax classification options for LLCs, how to know which one to choose, and how to go about the filing process for federal income tax returns so that you can get your business on the right tax track.
How Are LLCs Treated for Tax Purposes?
LLCs are commonly referred to as pass-through entities. This means that they are not taxed as a separate entity, like a corporate business structure. Instead, the income from the LLC passes through to the business owners and is claimed as personal income on their respective federal tax returns. That is unless you choose to have your LLC taxed as a corporation.
It turns out LLCs have a lot of flexibility in how they can be taxed, and the choice is up to you. By default, they are treated as pass-through entities, but you can also file a form to have your LLC taxed in the same way as a corporation. If you choose the latter option, the tax situation can become increasingly complex, and we highly recommend seeking the help of an accountant.
These tax classifications are broken down in more detail in the next section, but for now, it’s worth knowing that you have options.
Understanding LLC Tax Classifications
Tax classifications for LLCs fall into three categories:
- "Disregarded entity": For sole proprietors or single-member LLCs
- Partnership: For multi-member LLCs
- Corporation: For single- or multi-member LLCs that opt to be taxed as a corporation
Single-Member LLC Classification
For income tax purposes, single-member LLCs are treated as "disregarded entities," which means that the IRS treats them like they don’t exist as a separate business entity. Any profits earned from one are considered direct personal income of the owner as if they are self-employed. The owner can claim business expenses as deductibles, however.
There are some key differences between LLC business income and income from a paycheck, though. When you get a paycheck from an employer, the employer takes out taxes on your behalf. The employer also pays half of your Social Security and Medicare taxes. When you have self-employment income, you are responsible for paying all of these taxes, including what would usually be the employer’s portion to pay. This is called self-employment tax, and to avoid late fees, you will typically need to make payments throughout the tax year.
When you file taxes, you will include details of any tax payments you made during the year to determine if you still owe or are due a refund. In general, filing a tax return as a single-member LLC isn’t too much more complicated than filing a personal income tax return, but there are a few extra forms to fill out, as discussed in the next section.
Sole proprietors often choose this tax classification choice because it’s the simplest and most straightforward.
Multi-Member LLC Classification
By default, the IRS treats multi-member LLCs as partnerships. This works very similar to how single-member LLC taxes work. However, some additional paperwork is required to document how income and expenses are distributed among LLC owners (the details of how things are distributed are usually set out in the LLC’s operating agreement).
In the end, each LLC member will receive a statement from whoever is responsible for taking care of the LLC’s accounting, which indicates their share of income and expenses. Each member then treats this as personal taxable income on their individual tax returns, just as described for single-member LLCs.
Handling taxes as a partnership is the most straightforward option for multi-member LLCs, so it’s the default choice.
Corporate Entity Classification Election
Sometimes, it’s in the best interest of an LLC to be taxed as a corporation. Selecting this option requires filing Form 8832 with the IRS to indicate this choice. Being taxed this way treats the LLC as a separate entity with its own assets and business taxes while distributing wages or shares of corporate income to its members.
If you file as a corporation, a corporate tax return will need to be filed for the LLC indicating business profits and losses and wages paid to members. Each member will be treated as an employee of the corporation and should be issued a W-2 form indicating their wages and any taxes paid to claim on their personal tax returns.
Although filing as a corporation is more complicated, it might be a good idea if you plan on reinvesting a significant portion of profit back into the business. This allows that profit to be treated as belonging to the business and not to individual members, who must then pay taxes on it. Note that corporation tax rates and individual tax rates tend to be different.
How to File LLC Tax Returns
Here, we outline the key documents and paperwork needed to file under each classification.
Single-Member LLC Filing Requirements
As a single-member LLC, you will need to fill out Schedule C and Schedule SE when filing your individual income tax return (IRS Form 1040). Schedule C is where you will list all income and expenses for your LLC. Schedule SE is where you calculate your self-employment tax.
Information from Schedule C and Schedule SE is then entered into Schedule 1 of Form 1040. Results from that schedule are included in Form 1040 as "Other income from Schedule 1" and "Adjustments to income from Schedule 1."
Include these schedules in your return and fill out the remainder of your personal income tax return as usual. If you made payments on your estimated tax burden from your LLC throughout the year, you would include those payments in your Form 1040 when calculating if you owe additional tax or are owed a refund.
Multi-Member LLC Filing Requirements
The process for multi-member LLCs begins when the LLC files an informational tax return Form 1065, known as a partnership return. In this form, you’ll enter all of the information for the LLC’s profits and losses and how those were distributed to each member. For each member, an accompanying Schedule K-1 must be filled out, indicating their share of profits and losses.
Each member then uses their Schedule K-1 to complete their personal income tax return. Net income or loss from Schedule K-1 is reported on Schedule E. Then, just as with single-member LLC taxes, a Schedule SE is filled out for self-employment tax, and information from Schedule SE and Schedule E is entered into Schedule 1.
Finally, the results from Schedule 1 are entered into the individual’s tax return when they file Form 1040, and they complete the rest of their tax return as usual.
Corporate Filing Requirements
To file as a corporation, LLCs must first file Form 8832 to change their default classification. From there, taxes are handled at the corporation level, and members should receive W-2s indicating their wages as they would from a traditional employer.
Because corporate taxes can be complex, it’s advisable to seek the help of a tax professional in handling all corporation income tax returns and associated filings.
Understanding State LLC Taxes and Fees
When it comes to state taxes, if you haven’t classified your LLC as a corporation for tax purposes, you simply pay personal state income tax on your earnings. However, most states have additional fees that LLCs must pay. These fees are usually due annually or biannually and can range from as low as $0 (in Arizona) to as high as $800 (in California).
If you chose a corporate designation for tax purposes, you would need to file a separate state income tax return for your business.
Estimating and Paying LLC Taxes
To avoid penalties, you need to pay taxes throughout the year on any income earned from your LLC if you expect to owe more than $1,000. IRS Form 1040-ES can be used to calculate your estimated taxes. Payments must be made quarterly throughout the year, with the first payment due on April 15, the second payment due on June 15, the third payment due on Sept. 15, and the fourth payment due by Jan. 15 of the following year unless you file your tax return before Feb. 1.
Estimated tax payments can be sent by mail in the form of a check or money order made out to "United States Treasury" and accompanied by an estimated tax payment voucher. Payments can also be made online via direct pay, debit or credit card, or using the Electronic Federal Tax Payment System (EFTPS).
Manage Your Tax Forms and Accounting With Skynova
A good bookkeeping system is important for managing your small business’s finances throughout the year. Consider taking advantage of Skynova’s account software and other applicable products to streamline your accounting and maximize your tax deductions.