How Much Does an LLC Pay in Taxes?

A Limited Liability Company (LLC) is a flexible business structure that offers owners liability protection, separating personal assets from business debts. This entity type is popular for its adaptability in management and operational structure. An LLC does not pay federal income tax directly as a standalone entity. Instead, its tax obligations are determined by its classification for federal income tax purposes, which generally defaults to a “pass-through” entity.

Federal Income Tax Classifications for LLCs

For federal income tax purposes, the IRS generally treats LLCs as “pass-through” entities. This means the business’s profits and losses are reported on the owner’s personal tax return, avoiding taxation at the business level. The specific tax treatment depends on the number of members and any elections made with the IRS.

Single-Member LLCs

A single-member LLC is considered a “disregarded entity” by default. The IRS taxes it as a sole proprietorship. Business income and expenses are reported on the owner’s individual income tax return, on Schedule C (Form 1040).

Owners of single-member LLCs taxed as sole proprietorships are responsible for self-employment taxes. This covers Social Security and Medicare taxes, totaling 15.3% of net earnings from self-employment. These taxes are reported on Schedule SE (Form 1040).

Multi-Member LLCs

A multi-member LLC is automatically classified and taxed as a partnership by the IRS. The LLC itself does not pay federal income tax. Instead, it files an informational return, Form 1065, reporting its overall income, deductions, and credits.

Each owner of a multi-member LLC receives a Schedule K-1 (Form 1065). Owners then report these amounts on their personal Form 1040 and pay income tax on their distributive share. Multi-member LLC owners are also subject to self-employment taxes on their share of the partnership’s earnings, regardless of whether the income is actually distributed.

S Corporation Election

An LLC can elect to be taxed as an S corporation by filing Form 2553 with the IRS. This election can offer tax advantages by allowing owners who work for the business to split their income into a “reasonable salary” and distributions. The salary portion is subject to payroll taxes (Social Security and Medicare), similar to employee wages.

Remaining profits distributed to owners as distributions are not subject to self-employment tax. The IRS requires that the salary paid to owner-employees be “reasonable compensation,” meaning it must be comparable to what other businesses would pay for similar services in similar industries. S corporations file Form 1120-S and issue Schedule K-1s to shareholders.

C Corporation Election

Alternatively, an LLC can elect to be taxed as a C corporation by filing Form 8832. When this election is made, the LLC becomes a separate taxable entity. The C corporation pays corporate income tax on its profits using Form 1120, at the corporate tax rate.

C corporation taxation involves “double taxation.” Profits are taxed at the corporate level, and then again when distributed to owners as dividends, which are taxed at the individual owner’s income tax rate. Owner-employees of a C corporation are taxed on their salaries via Form W-2, and these salaries are deductible business expenses for the corporation.

Additional Taxes and Fees

Beyond federal income tax classifications, LLCs and their owners may be subject to various other taxes and fees. These obligations are separate from how the LLC’s income is treated for federal purposes and can significantly impact the overall tax burden.

State Annual Fees and Franchise Taxes

Many states impose annual registration fees or franchise taxes on LLCs. These fees vary widely, from nominal annual report fees to more substantial annual franchise taxes, regardless of income. These recurring fees are required to keep the LLC in good standing.

Sales and Use Tax

LLCs that sell tangible goods or certain services may be required to collect and remit sales tax. Sales tax is imposed at the point of sale on taxable goods and services, and the rates and rules vary by state and local jurisdiction. Use tax is a complementary tax that applies when a taxable item is purchased without sales tax but is then used or consumed within a state where it would normally be subject to sales tax.

Payroll Taxes

If an LLC has employees, it is responsible for payroll taxes. These include Social Security and Medicare taxes (FICA taxes), which are jointly paid by the employer and employee, and federal unemployment tax (FUTA). Employers withhold the employee’s share of FICA taxes and income taxes from paychecks and remit them along with the employer’s share. State unemployment taxes (SUTA) are also paid by the employer. Federal payroll taxes are reported using forms like Form 940 for FUTA and Form 941 for FICA taxes, with deposits made monthly or semi-weekly.

Factors Influencing Your LLC’s Tax Bill

The amount of tax an LLC or its owners pay is directly influenced by several financial factors within the business. These elements determine the base upon which taxes are calculated, regardless of the chosen tax classification.

Net Profit and Deductions

The net profit of the business, calculated as business income minus deductible expenses, is the primary determinant of taxable income. The IRS allows businesses to deduct ordinary and necessary expenses incurred in the operation of the business. These can include a wide range of costs such as rent, utilities, office supplies, advertising, and professional fees. Maximizing eligible deductions can significantly reduce the overall taxable income.

Owner Compensation and Distributions

How owners take money out of the business also affects their personal tax liability. In single-member LLCs and multi-member LLCs taxed as partnerships, owners take “owner’s draws” or “guaranteed payments.” These are not considered salaries and are not subject to tax withholding at the business level, but the owner still pays self-employment taxes on this income. For LLCs electing S corporation status, a “reasonable salary” is subject to payroll taxes, while remaining distributions are free from self-employment tax.

Qualified Business Income (QBI) Deduction

The Qualified Business Income (QBI) deduction, also known as Section 199A, allows eligible pass-through business owners to deduct up to 20% of their qualified business income. This deduction directly reduces the owner’s taxable income on their personal tax return. This deduction has income thresholds and limitations based on the type of business and the amount of W-2 wages paid by the business.