LLC Taxes: What They Are & How They Work

What are LLC Taxes

A limited liability company (LLC) is a type of business structure that protects its owners against personal liability while still offering the flexibility of a partnership or sole proprietorship. When an LLC is formed, its members (LLCs don’t have shareholders) get to choose how the LLC will be taxed. 

In most cases, LLCs are “pass-through entities.” This “pass-through” taxation means the company’s profits are distributed to the owners (members), who then report this income on their individual tax returns. As a result, the company’s profits are only taxed once, on the individual level, avoiding the double taxation often seen with corporations. 

Multi-member LLCs, however, can choose from different types of tax treatment. For example, they can choose to be taxed as corporations, paying taxes on company income before it is distributed to owners (when it would be taxed again as personal income). 

Additionally, some states levy a franchise or capital values tax on LLCs. Understanding your state’s specific regulations and how they apply to your LLC is crucial for accurate tax planning and filing.

Other taxes that LLCs may be responsible for include:

• Payroll withholding for employees, if they have any
• Real estate taxes, if they own property
• Capital gains taxes, if they sell property for a gain and are taxed as a corporation

LLC Tax Structures

When establishing an LLC, one of the key considerations is the selection of an appropriate tax structure. The tax structure you choose can have significant implications for your business’s financial management, affecting how much you pay in taxes, the paperwork your business is required to file, and potentially owners’ exposure to personal liability. 

Some tax structures that LLCs can use include:

Single-member LLC treated as a disregarded entity

In this structure, the IRS treats a single-member LLC as a disregarded entity for tax purposes. This means the LLC’s activities are reflected on the owner’s federal tax returns, just like a sole proprietorship. All the profits and losses of the LLC pass through to the owner’s personal tax return.

Multiple-member LLC taxed as a partnership

If an LLC has more than one member, the IRS automatically classifies it as a partnership for tax purposes unless another structure is selected. Under this structure, the profits and losses of the LLC are tracked and reported on the LLC’s tax return. However, the LLC itself does not pay taxes. Instead, the profits and losses are passed through to the members, who report and pay the taxes on their individual tax returns.

LLC taxed as a C corporation

An LLC can also choose to be taxed as a C corporation. To do so, the LLC must file IRS Form 8832, Entity Classification Election, and elect to be taxed as a corporation. If the LLC is taxed as a corporation, it is subject to corporate income tax. This means the LLC’s profits are taxed at the corporate level, and any dividends distributed to the members are taxed again at the personal level.

(It’s worth noting that this double taxation is one of the most significant disadvantages of corporations and may result in owners paying more in total taxes.)

LLC taxed as an S corporation

An LLC can also choose to be taxed as an S corporation. This helps owners avoid the double taxation issue associated with being taxed as a C corporation. In an S corporation, the profits and losses are passed through to the owners’ personal tax returns, just like in a disregarded entity or partnership. However, an LLC taxed as an S corporation allows the members to potentially take advantage of additional tax savings strategies, such as reducing self-employment taxes.

Note: This information is not tax advice. Consult a tax professional to determine the best tax structure for your circumstances.

How LLC Taxes Work

LLC taxes work based on the tax structure that the business chooses, which can be either a partnership, sole proprietorship, or an S- or C corporation. In the case of a partnership or sole proprietorship, the LLC is viewed as a “pass-through” entity for tax purposes. This means the company itself doesn’t pay taxes. Instead, the company’s profits and losses are passed through to the owners (members), who report them on their personal income tax returns.

On the other hand, if the LLC elects to be taxed as a corporation, the company pays taxes on its earnings at the corporate level. Afterward, if dividends are distributed to the owners, these distributions are taxed again at the individual level, leading to what’s known as double taxation. However, the advantage of a corporate structure is that it allows the owner to keep a portion of the profits in the company (retained earnings) and pay a lower corporate tax rate.

LLC Tax Tips

Understanding the taxation process for limited liability companies (LLC) can be complex but is crucial for maintaining your business’s financial health. The structure you choose for your LLC impacts how taxes are assessed and paid. Whether your LLC is taxed as a partnership, a corporation, or under another structure, it’s important to be aware of the specific tax requirements that apply.

Here are some tips to help you optimize your tax treatment for your LLC:

• Choose the right business structure. The first step to properly manage your LLC tax is to choose the most suitable business structure. The structure can be a partnership, corporation, or sole proprietorship. Your business structure impacts how your taxes are calculated and paid. 
• Keep accurate records. Maintaining accurate and detailed financial records is crucial for tax filing and legal protection. It can help you track your income, expenses, and potential deductions. It’s also helpful in the case of an audit or if your business is ever sued so you can maintain the personal legal protection afforded to you by an LLC.
• Understand deductible expenses. Certain business expenses can be deducted from your taxable income, reducing your overall tax liability. Common deductible expenses include office rent, utilities, business travel, and even certain meals. If you run your business from home, you may also be able to deduct a portion of your home utilities and other bills. Talk to a tax professional to confirm which expenses can be deducted.
• Pay estimated quarterly taxes. If your LLC is likely to owe $1,000 or more when you file your annual return, you should pay estimated taxes quarterly to avoid penalties at the year-end. This also helps to spread out your tax obligations over the year and avoid a large lump sum payment.
• Consult with a tax professional. LLC taxes can be complex, particularly if your business has a complicated structure or operates in multiple states. Working with a tax professional can help ensure you’re keeping accurate financial records, taking advantage of all available deductions and credits, and staying compliant with all state and federal tax laws.

One of the easiest ways to work with a tax professional is by tracking your income and expenses in QuickBooks and sharing it with your accountant. Quickbooks automatically syncs with your business banking and credit card information, so you can track and categorize expenses easily. Click below to try QuickBooks and save 30% for the first six months.