How Much an LLC Gets Taxed and Your Options

A Limited Liability Company (LLC) offers business owners a flexible tax structure. Unlike traditional corporations or partnerships, an LLC’s tax classification is not fixed, providing choices that significantly influence their overall tax burden. This adaptability allows businesses to select a tax structure aligning with their operational needs and financial objectives, impacting their federal and state tax burden.

Default Federal Tax Treatment for LLCs

The Internal Revenue Service (IRS) treats LLCs as “pass-through” entities by default. This means the business itself does not pay federal income tax; instead, profits and losses pass directly to the owners’ personal tax returns. This structure avoids double taxation, where income is taxed once at the business level and again when distributed to owners.

For a single-member LLC (SMLLC), the IRS disregards the entity as separate from its owner for federal income tax purposes. The business’s income and expenses are reported directly on the owner’s personal tax return, Form 1040, typically via Schedule C (Profit or Loss from Business). Net earnings are calculated and included in the owner’s gross income. The LLC itself does not file a separate federal income tax return, simplifying compliance for many sole proprietors.

When an LLC has multiple members, the IRS treats it as a partnership for federal income tax purposes. The LLC must file an informational return, Form 1065, U.S. Return of Partnership Income. This form does not calculate or pay income tax but provides an overview of the partnership’s income, deductions, gains, and losses.

Each member of a multi-member LLC receives a Schedule K-1. This document details their individual share of the LLC’s profits or losses, which they report on their personal Form 1040. Tax liability for their share of income is paid at their individual income tax rates, maintaining the pass-through characteristic where income is taxed only once at the owner level.

Electing Alternative Federal Tax Structures

An LLC can elect to be taxed differently from its default classification, offering strategic advantages depending on the business’s size, profitability, and owner compensation structure. These elections allow an LLC to be treated as either an S corporation or a C corporation for federal income tax purposes. The choice impacts how income is taxed, how owners are compensated, and the overall tax burden.

Electing S corporation status allows an LLC to maintain pass-through taxation benefits while potentially offering payroll tax savings for owner-employees. To make this election, the LLC must file Form 2553, Election by a Small Business Corporation, with the IRS. It must meet eligibility criteria (e.g., 100 or fewer shareholders, single class of stock). An S-Corp avoids corporate-level income tax; profits and losses pass through to owners’ personal tax returns, similar to a partnership.

A distinction for an S-Corp is the requirement for owner-employees to be paid a “reasonable salary” for services rendered. This salary is subject to federal payroll taxes, including Social Security and Medicare contributions. Any remaining profits distributed to owners beyond this reasonable salary are considered distributions and are not subject to self-employment or payroll taxes, which can result in tax efficiency. The LLC, as an S-Corp, files Form 1120-S, U.S. Income Tax Return for an S Corporation, and issues Schedule K-1s to its owners, detailing their share of income, deductions, and credits.

Alternatively, an LLC can elect to be taxed as a C corporation by filing Form 8832, Entity Classification Election. This choice makes the LLC a separate taxable entity, distinct from its owners, for federal income tax purposes. As a C-Corp, the business itself pays corporate income tax on its profits at the corporate tax rate, currently a flat 21%. The C-Corp files Form 1120, U.S. Corporation Income Tax Return, to report its income and pay its taxes.

The implication of C-Corp election is “double taxation.” Corporate profits are first taxed at the corporate level. Then, if the corporation distributes these after-tax profits to shareholders as dividends, those dividends are taxed again at the individual shareholder level. This second layer of taxation significantly increases the overall tax burden on business earnings, making C-Corp status less appealing for smaller, privately held LLCs unless specific strategic advantages, such as attracting venture capital or retaining earnings for reinvestment, outweigh the double taxation aspect.

Other Taxes Applicable to LLCs

LLCs face various other tax obligations beyond federal income tax structures. These include self-employment, state-level, payroll, and sales taxes.

Owners of LLCs taxed as sole proprietorships or partnerships are subject to self-employment taxes on their share of the business’s net earnings. This tax covers Social Security and Medicare contributions, amounting to 15.3% on net earnings up to the Social Security wage base and 2.9% for Medicare on all net earnings. This obligation applies to the entire distributable profit. Electing S-Corp status can alter this, as only the “reasonable salary” paid to owner-employees is subject to these payroll taxes, while distributions are not.

State-level taxes vary significantly and can include annual registration fees, franchise taxes, gross receipts taxes, and state income taxes. Many states impose an annual fee or renewal charge for maintaining an LLC’s active status, ranging from under $100 to several hundred dollars. Some states, like California and Texas, levy a franchise tax or similar privilege tax on LLCs based on factors such as gross receipts or net worth, regardless of profitability. Certain states may also impose an entity-level income tax on LLCs, even if they are pass-through entities for federal purposes.

If an LLC has employees, including owner-employees taking a salary under an S-Corp or C-Corp structure, it becomes responsible for withholding and remitting payroll taxes. These include the employee’s share of FICA (Social Security and Medicare taxes) and the employer’s matching share. Employers must also pay federal unemployment tax (FUTA) and state unemployment tax (SUTA), which fund unemployment benefits. These obligations involve regular filings and payments to both federal and state authorities.

LLCs that sell taxable goods or services are responsible for collecting and remitting sales tax to state and local tax authorities. The applicability and rates of sales tax depend on the nature of the goods or services sold and the location of the transaction. Businesses must register with the state’s tax department to obtain a sales tax permit and then accurately collect, report, and remit these taxes according to state-specific schedules, which can be monthly, quarterly, or annually.