How are Limited Liability Companies taxed?

An LLC is not a separate tax entity, it is a pass through entity like a sole proprietorship or a partnership. All the profits and losses of a business pass through it to its members and then they report it as their personal tax. Some states charge LLC federal income tax while others do not. Depending on the number of its members, LLC is taxed by the IRS. A single-member Limited Liability Company is treated differently than a multi-member Limited Liability Company.

Taxes of Single-Member LLC

Elective Status: Most Single-member LLCs can be taxed as S-Corp or C-Corp.

Default Status: IRS consider a single-member LLC as a Disregarded Entity. This means owner is looked at when considering the tax. This disregarded entity has subtypes. It also depends on the owner, which means:

• If an LLC is owned by a non-US resident, then his LLC will be treated as the same way that individual is treated for the tax.
• If LLC is owned by a US resident, the tax is treated like a Sole Proprietorship.
• If your LLC is owned by a third party or another company, LLC is taxed like a branch of your company.

Taxes of Multi-member LLC

Elective Status: Similar to the Single-member LLC, multi-member LLC can be taxed as S-Corp or C-Corp.

Default status: Multi-member LLC is taxed like a Partnership. If a multi-member LLC is owned by a married couple, then it is taxes as a Qualified Joint Venture.

LLC considered as Disregarded Entity

When an LLC is considered as a disregarded entity by the IRS, it means the IRS will consider the owner and his LLC as one and same. (Although LLC and the owner are considered as different from each other). If this is owned by a single member, then it is taxed as an LLC sole-proprietorship. But if it is owned by another company, then it is taxed as a division of the parent company.

Tax for a married couple LLC

A married couple is taxed as a multi-member LLC or a partnership. However, they can elect to be taxed as a Qualified Joint Venture. Then they will be taxed as ‘one’. They just have to file one return. It means increased tax savings, reduced accounting fees, record-keeping and other paperwork. They will also get extra credit for social security and medicare with no extra taxes.

Important: Only married couple LLCs formed in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin are allowed be qualified as Qualified Joint Venture. 

LLC taxed as an S-Corp.

This applies to single-member LLC and Multi-member LLC both. An LLC does not have to keep its default tax classification with IRS if it wants to be taxed as an S-Corp, it needs to file Form 2553. The owner of an LLC (taxed as sole-propreitorship) will pay self-employment taxes on all profits in the company. These taxes are 15.3 percent of net income (after expenses).

When the LLC is taxed as an S-corp, the owner also becomes the employee of his company and he has must take a salary (subject to 15.3% self-employment tax). But the profits that remain afterwards, will not be a subject to this tax.

The owner will also suffer additional expenses like payroll processing, payroll tax returns, additional bookkeeping, accounting fees and filing Form 1120-S corporate tax return. The higher he profits, the higher will be his tax savings.

LLC taxed as a C-Corp.

This applies to single-member LLC and Multi-member LLC both. An LLC does not have to keep its default tax classification with IRS if it wants to be taxed as an S-Corp, it needs to file Form 8832. The LLC taxed as C-Corp usually apply to small businesses.

The biggest advantage of an LLC being taxed as a C-corp is ‘income splitting’. A business owner makes enough money that he leaves a part of it in the company. He takes a salary but not so much that it eliminates the profits of the company. ‘Splitting income’ can make him pay lower tax. But this strategy is only for those who are experienced or it can lead to Accumulated Earning Tax (leaving profits in company for too long).

The disadvantage of LLC being taxed as a C-Corp is double taxation. Unlike a pass through entity, an LLC with C-corp tax classification and its members must file a return with IRS. This is because you are being taxed on corporate and personal level both.

You must stay organized so that you file the correct forms and pay the taxes on time. If you need extra time, you should apply for extension so that you do not have to pay penalties. With this, you will be able to run your business smoothly and make your customers happy.