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What LLCs Need to Know About Taxes

business.com editorial staff
business.com editorial staff

Here's what you need to know about filing taxes as an LLC.

  • Just like individuals, all businesses are responsible for filing and paying taxes. The amounts of taxes you owe depends on your profits and the tax rate. As the owner of an LLC business, the way you pay taxes depends on whether you are a sole proprietor or a partner.
  • As an owner of an LLC, it's important to understand how income tax is determined and to understand when you are responsible for paying self-employment tax. You'll also need to determine if you want to be taxed as a corporation or a sole proprietor.
  • As part of a multimember LLC, you are responsible for filing your share of the profits and losses as well as paying taxes on your share of the company's profits.

All businesses must pay taxes, with the amount determined by the level of your profits and the tax rate. If you have a limited liability company (LLC), you get the benefit of deciding to file your federal and state income taxes as a corporation or as an individual, so you can choose the status that provides the best result for you.

For example, say you and your business partner drive together to a client meeting and on the way injure someone in a car crash. The injured party then sues your company.

"While the LLC might have to pay damages in a lawsuit, if the LLC is operated legitimately, you and your business partner's personal assets can be protected," said Hal Shelton, SCORE mentor, angel investor and author of The Secrets to Writing a Successful Business Plan.

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Make your business genuine.

Legitimacy, as stated above, means much more than having the LLC certificate from the state where you applied for it. You need to operate your business as a separate entity from your personal life, says Shelton. That means having a business bank account, a credit card only used for business expenses and even stationery with your company's name on the letterhead. Including these components in the structure help make your LLC successful.

"Otherwise, lawyers (in case of a lawsuit) may say your LLC is a sham," said Shelton. "If they are successful with this claim, your personal assets could be at risk."

Once you've created an authentic LLC, you need to know how it will be taxed. [In debt and in need of relief? Check out our best picks and reviews of tax debt relief companies.]

Understand how income tax is determined.

First, you apply to your state to become an LLC. Your state charges you a fee for this designation; anywhere from $100 to $250 (not a tax) per year. When you file your federal income tax, you will elect to be taxed either as a corporation or as an individual/sole proprietor. If you select "corporation," the LLC will prepare the tax return on IRS Schedule 1120-C or 1120-S. If you decide on "individual," it is called a tax pass-through, since you, not the LLC, will be paying the taxes.

An example of the individual method would be a company that made $100,000 in profits last year and has three owners: Owner A and Owner B each received 30% of the profits, while Owner C is entitled to 40%. This allocation was previously agreed upon and is included in the LLC operating agreement. The LLC fills out IRS Form 1065 and sends it to the IRS – this is known as an information return, because the three owners will be paying the taxes. The LLC also prepares a Schedule K-1 for each of the owners showing their share: Owners A and B got $30,000, while Owner C received $40,000.

"Then each of the owners must file a Form 1040 with an attached Schedule C, where they will show their share of the LLC profits," said Shelton. "The IRS will then match the Form 1065 from the LLC and the three owners' Schedule Cs to make sure all the taxes have been paid."

That's the pass-through and where the actual taxes are paid. [Looking for tax software? Check out our reviews and best picks on our sister site, Business News Daily.]

Give every entity its share.

All but seven states in the U.S. require residents to pay state income tax. Those 43 states have different tax rates. The amount you pay depends on your overall income and your state's tax rate.

An LLC also pays the same taxes as any business would. If you have employees, you'll pay wage taxes (Social Security, Medicare and unemployment insurance). Selling a product or service that's subject to sales tax means you need to remit those taxes to your state and any other state you sell in, says Shelton. An LLC that owns real estate might incur property tax. The amount of these taxes is calculated according to a different formula for each one.

"Because the process of how LLCs are taxed is not intuitive, I recommend you seek counsel by contacting a SCORE mentor," said Shelton. "You can meet face to face [or] via email, telephone or video conference."

You can visit SCORE to find a mentor. Surround yourself with advisors and counselors, because the more knowledge you can tap into, the better you'll run your business.

How single vs. multiple members of LLCs pay taxes

If you are an owner or part owner of an LLC, one of the most common questions people have is how to pay income tax, state tax and etc. If you are the sole owner of the LLC, it is considered a disregarded entity, which means you are responsible for reporting all profits and losses on your 1040 form. If the business provides a service or sells one or more products, you are responsible for the self-employment taxes on all profits. However, if the LLC Company is considered a passive business, you do not pay self-employment taxes, but will file profits as supplemental income.

If your LLC business has two or more owners, for federal income tax purposes, it is automatically classified as a partnership or multimember LLC by the Internal Revenue Service. As a single member of a multimember LLC, you will pay a portion of the taxes for the LLC on your own personal income tax return. The tax amount paid by each member is typically in proportion to their interest in the LLC business. For example, if you own 30% of the LLC, you are responsible for 30% of the losses and 30% of the profits, so you will file your taxes on 30% of the total LLC profit.

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