Limited liability company taxation is very formulaic, which allows new LLC owners to more easily predict what their tax liability will be. Llcs have a set of default rules along with several elections you may take to alter your llc’s tax treatment. The default LLC tax laws change depending on the number of members (owners) the limited liability company has.
Single-Member LLC Default Tax Rules
A single-member LLC (only one owner) is treated by default as a disregarded entity by the IRS. There is no llc tax return to file because the IRS does not consider your Limited Liability Company to be a separate entity. Instead, the income and deductions of the LLC flow through or pass through to the single member. The one owner then claims the income and deductions on his Schedule C, Profit or Loss From a Sole Proprietorship, and pays the llc taxes.
In this way, single member llc taxation is the same as sole proprietorship taxation if the owner keeps the default rules.
Multiple-Member LLC Default Tax Rules
Limited liability companies with multiple members are treated by the IRS as partnerships. Like in a single-member LLC, the profits and deductions from a multiple-member LLC flow through or pass through to the owners to be claimed on their own personal income tax returns. Unlike a single-member llc, limited liability companies with multiple owners must file an informational tax return with the IRS. No money is due with the informational LLC tax return.
Form 1065 is for partnership tax returns, but it is also the appropriate llc tax form for default multi-member LLCs. Each member must also receive Form K-1, which is sent along with the individual member’s personal income tax return.
Electing Different LLC Taxes
LLC taxation gets a bit trickier when you deal with possible elections. The good news is that if you wish to keep the default llc tax rules, you do not have to do anything; your LLC is automatically a disregarded entity and you automatically pay taxes in line with one of the llc tax laws above.
You may, however, elect to be taxed as a corporation. This decision does not affect the operation of your LLC, your limited liability, your state requirements, or anything else; it only affects how the IRS taxes your llc.
Use IRS Form 8832 to make your initial election or to change your LLC tax status later. The rules for election are the same for single-member LLCs and limited liability companies with more than one member. The only difference is that single-member LLCs choose to be taxed as a sole-proprietorship or corporation, while multi-member LLCs choose to be taxed as a partnership or corporation.
Complicating matters a bit is the fact that there are actually two types of corporate taxation: Subchapter S and Subchapter C. Those corporations that elect the tax rules under Subchapter S are referred to as S-Corporations, while those that elect under Subchapter C are C-Corporations. The tax law varies slightly between the two, and how those rules affect LLCs will be discussed below.
Effect of LLC Tax Election
Since your LLC tax status only has an effect on how much you must pay in llc taxes, business owners tend to want the status that saves them the most money. This is one of the biggest llc tax advantages; you get to choose whatever structure most benefits you. Figuring out which one to take, though, can be confusing and you should hire a competent tax attorney or CPA if you need assistance.
Here are some general guidelines:
- Single Member LLC (Disregarded Entity) – A single-member llc (one owner) must pay self-employment tax. In addition to claiming all profits and losses on Schedule C, you must also calculate self-employment tax due on Schedule SE.
- Multi Member LLC (Partnership) – A multi-member llc (more than one owner) also pays self-employment taxes. The limited liability company itself files an informational llc tax return (Form 1065) and issues a K-1 to each member. Then, the llc taxes are paid by each member according to his share of the profits and losses. Like in a single-member LLC, each member files a Schedule C and calculates self-employment tax on Schedule SE.
- LLC Treated as an S-Corporation – Profit disbursements to members in S-Corp LLCs must be reported on IRS tax return Form 1120S. Your Limited Liability Company will also owe payroll tax for wages paid to employees, including employees who are members. However, the S-Corp LLC tax advantages are that it pays neither self-employment tax (like single-member disregarded entities or multi-member partnership LLCs) nor corporate income tax (like C-Corp LLCs).
- LLC Treated as a C-Corporation – Corporate income tax is due with Form 1120 if you elect to have your limited liability company taxed as a C-Corp. Additionally, any profits paid to owners/members in the form of dividends (unearned income) are subject to dividend tax. C-Corp LLCs also owe payroll tax for wages, but the owners do not have to pay self-employment tax.
Which LLC tax election you make is a personal choice that should be discussed with all members and a licensed tax attorney or CPA. What selection offers the most llc tax advantages now might not be as advantageous later as your business grows. Similarly, what may be appropriate for a large limited liability company might not be right for you if you plan to keep your LLC small. Llc taxes can be complicated, and you should understand your obligations fully before you file your first llc tax return.
Deciding between an LLP and LLC can be difficult unless you fully understand the differences between the two entities. There are many similarities between the LLP and LLC, but there are a few key differences you must examine in making your choice. State laws vary, and it is possible that your type of business is restricted to either the LLP or LLC, so knowing the laws of your state is also important. If you have any confusion on this point, speak with an attorney licensed to practice law in your jurisdiction. The Secretary of State’s office may also be able to provide some insight.
You are permitted to form an LLC in any U.S. state regardless of where you reside or where you intend to do business. Though some states offer more advantages to LLC owners, there are two negatives to creating an LLC in other states: you must register as a foreign LLC in each state you intend to conduct business, and you must designate a registered agent in the state in which you started your LLC.
There are two states commonly touted as the best for LLC formation: Delaware and Nevada.
There are three requirements you must meet before you may take a home office deduction: the home office must be (1) a specific area of your home (2) used regularly and exclusively (3) as your principal place of business. The third requirement may also be met if you use the home office to meet with patients, clients, or customers even if the office is not your principal place of business.
There are two types of corporations: C Corporations (or C Corps) and S Corporations (or S Corps). Both entities are identical in most ways and the variations occur largely in taxation; S Corps are pass-through tax entities — like LLCs — while C Corps pay a separate corporate tax. All corporations are C Corps unless Form 2553 was filed with the IRS to specifically elect S Corp taxation.