An LLC can be taxed as a sole proprietorship, partnership, S corporation or C corporation.
- A limited liability company is a type of business structure, not an IRS-recognized form of taxation.
- An LLC can file taxes as a sole proprietorship (one member), partnership (more than one member), S corporation or C corporation.
- An LLC must adhere to federal guidelines, as well as specific regulations set by the state they operate in.
How is a limited liability company taxed?
A limited liability company (LLC) is a pass-through entity, meaning that all of the profits of the LLC "pass through" to the owner or owners of the LLC (owners are also referred to as members). An LLC itself does not pay federal income taxes, but the owners or members of an LLC must report profits and losses on their personal income tax return.
The IRS treats your LLC either as a sole proprietorship or a partnership depending on how many members your LLC has and the tax advantages you qualify for.
"A single-member LLC is taxed as a sole proprietorship and is a disregarded entity, meaning that the owner and LLC are separate entities," said Joshua Zimmelman, owner of Westwood Tax & Consulting. "A multimember LLC typically pays income tax as a partnership, so the individual members pay tax based on their share of ownership. Some LLCs elect to be classified as a corporation for tax-advantage purposes. They continue to operate as an LLC but are taxed as a corporation or S-corp."
Filing as a sole proprietorship or partnership
If you are a single-member LLC, your business is treated by the IRS as a sole proprietorship, which means that you will not have to file separate entity taxes; instead, you will need to report the business's profits or losses on your individual income tax return. Only the profit (income minus expenses) is taxed, and the rate at which it is taxed will depend on your regular federal and state income tax brackets.
"The profit that's generated by an LLC that is taxed as a sole proprietorship is subject to both income tax and self-employment taxes, which represent the employee and employer portions of Social Security and Medicare taxes (15.3% total)," said David Cawley, a partner at Fraim, Cawley & Company, CPAs.
Multimember LLCs, or partnerships, are taxed similarly to sole proprietorships – the business does not have to pay taxes at an entity level, but the members must pay income taxes on their personal income tax returns. To calculate how much money each member of the LLC will be taxed on, divide the business's net income among the members according to their ownership percentage. [Read related article: "Tax Filing Tips for Independent Contractors"]
Filing as an S corporation
Some LLC owners may opt to file as a corporation. If an LLC files as an S corporation, each member is treated as an employee and pays themselves a reasonable salary that they must pay income tax on. Cawley said this "reasonable compensation" is often based on the owner's training, experience, responsibilities and time devoted to the business.
After salary distributions, any corporate earnings may be treated as unearned income and won't be subject to self-employment taxes. Some businesses with a high level of income may find it beneficial to file taxes as an S-corp, since members who file as a sole proprietorship or partnership are subject self-employment income tax on all profits.
Cawley provided a scenario that demonstrates the differences in taxation based on an LLC that has $100,000 in profit.
"If the LLC is treated as a sole proprietorship, the owner will have to pay $15,300 in self-employment taxes before income taxes are even considered," said Cawley. "In the same example, if the LLC is taxed as an S-corp and the owner pays themselves a reasonable salary of $40,000, only the $40,000 is subject to self-employment tax and income taxes. The remaining $60,000 is still subject to income taxes but not self-employment taxes, saving the owner nearly $10,000 in taxes annually."
If your LLC is currently operating as a sole proprietorship and your business profit is growing consistently, you may want to consult with a tax expert to see if electing S-corporation status makes sense for your LLC. However, Aaron Messing, founder of Messing, PC, said that LLC business owners should be aware of the limitations on the availability of S-corporation election.
He listed the following legal requirements for S-corp consideration:
- An S corporation cannot have more than one class of stock.
- An S corporation cannot have more than 100 stockholders.
- With certain limited exceptions, only U.S. citizens or residents can be stockholders.
- An eligible U.S. entity must make a S-corporation election using IRS Form 2553 no more than two months and 15 days after the beginning of the tax year the election is to take effect to be timely.
Filing as a C corporation
It is technically possible for an LLC to file taxes as a C corporation, but it is generally the least-favorable option. Although the rate at which C corporations are taxed was recently reduced due to the Tax Cuts and Jobs Act (TCJA), they are still subject to a 21% tax rate for federal income taxes. Additionally, each member will be taxed on any of the remaining funds they take out of the business, whether it be through salary or dividends.
"If the owner pays themselves a salary, the salary is subject to income taxes, 7.65% for Social Security and Medicare, and the company has to pay another 7.65%," said Cawley. "The owner will also have to pay income taxes on any dividends they take from the business. This is commonly referred to as 'double taxation' and is a reason many business owners and CPAs are getting away from choosing this structure."
What are the tax advantages of an LLC?
One of the primary tax advantages of an LLC is flexibility. LLC members have a few taxation options available to them, which can result in tax savings.
Another tax advantage of a limited liability company is business expense tax deductions. Under the TCJA, qualifying pass-through taxation entities can deduct 20% of their business income.
"The biggest tax advantage is that expenses related to the income from the LLC can be written off so long as they are regular and ordinary business expenses," said Cawley. "Regular W-2 employees, on the other hand, can no longer deduct expenses related to work, such as mileage or equipment, after changes made by the Tax Cuts and Jobs Act of 2017."
LLCs and self -employment taxes
According to NOLO, self-employment taxes are different from other types of taxes for several reasons. First, given that they are not actually employees, those who are self-employed do not have certain contributions withheld from their paychecks, such as Medicare and Social Security. Therefore, those who are self-employed are required to pay these in the form of self-employment taxes, which must be paid by the self-employed party or parties. However, if there are owners who are not active in the LLC, or those who may have helped with financing but do not play an active role in the business or help make decisions, may be exempt from paying those taxes.
Additionally, each owner who must pay self-employment tax must also report the amount due on Schedule SE, which must then be submitted annually alongside the person's tax return. LLC owners, as well as their partners and sole proprietors in general, are required to pay twice as much self-employment tax as regular employees. This is due to the fact that regular employee contributions to the self-employment tax are expected to be matched by their employers. Moreover, the self-employment tax rate for business owners is approximately 15.3% of one's net income, or up to an annual threshold and then 2.9% for income above the threshold amount.
Estimating and paying income taxes
According to the IRS, sole proprietors, partners, and S-corporation shareholders typically use Form 1040 ES to figure out their estimated taxes. To properly calculate your estimated tax, you need to first figure out what your expected adjusted gross income will be for the year.
One helpful hint suggested by experts is to use your income deductions, as well as credits from the previous year, as a starting point. In particular, you may want to use your previous federal tax return as your guide. If it turns out that you have estimated your income too high, you can simply complete another 1040-ES Form worksheet to help you refigure your estimated tax for the next quarter. On the other hand, if your estimated earnings are too low, you must complete another Form 1040-ES worksheet to properly recalculate your estimated tax for the next quarter. Either way, you need to be sure to estimate your income as accurately possible to avoid potentially harsh penalties.
You must also make adjustments to account for changes in your own situation, as well as to account for recent changes in the tax law. Either way, you must be sure to pay the right amount of taxes for each tax year as there are stiff penalties for underpaying. However, most are able to avoid the penalties as long as they owe less than $1,000 after the proper calculations have been made.
To figure out their estimated tax, corporations typically use Form 1120-W.
Do you have to pay LLC taxes if you made no money?
It depends. If your LLC did not make a profit, you will likely not have to pay income taxes, but you may still be required to file a tax return or pay local property taxes for equipment you own and payroll taxes for employees.
Whether or not you have to file taxes for an LLC with no income largely depends on how the LLC is taxed and whether your LLC had no activity or it just didn't make a profit.
Zimmelman listed the following guidelines for LLCs that did not make a profit:
LLC filing as a sole proprietorship: You don't need to file if there are no business expenses or income. You still need to file your personal tax return, but you don't need to include the LLC's info on your Schedule C if there has been no activity.
LLC filing as a partnership: You don't need to submit a partnership return if there are no business expenses to deduct or income.
- LLC filing as a corporation: File a federal return every year, even if there was no income and no business activity.
"If your LLC had business activity for the year, you should still include the LLC information on your tax return, even if you didn't earn a net profit," said Zimmelman. "You can deduct business expenses, but the IRS only lets you claim losses on your business for three out of five years. After that, they may reclassify your business as a hobby, which means you can no longer claim business expenses."