How Much Will My LLC Pay in Taxes?

A Limited Liability Company (LLC) offers a flexible business structure, but its tax obligations are often misunderstood. Its federal income tax classification depends on its ownership structure and any elections made with the Internal Revenue Service (IRS). This flexibility allows an LLC to be taxed in several ways, influencing the overall tax burden on its owners. The specific tax treatment determines how income and expenses are reported, as well as the applicable tax rates.

Default Federal Income Taxation of LLCs

By default, the IRS treats an LLC as a “pass-through” entity for federal income tax purposes. The LLC itself does not pay federal income tax. Profits and losses pass directly to the owners, who report these amounts on their personal tax returns. This structure avoids the double taxation that can occur with traditional corporations.

For a single-member LLC, the IRS considers it a “disregarded entity,” taxed as a sole proprietorship. The owner reports the LLC’s income and expenses on Schedule C (Form 1040), filed with their individual income tax return.

A multi-member LLC is, by default, treated as a partnership for federal tax purposes. The LLC files an informational return, Form 1065, to report its income, deductions, and credits. It then issues a Schedule K-1 to each member, detailing their share of the LLC’s income or loss.

Each member reports their share of the LLC’s income or loss from the Schedule K-1 on their personal tax return. The federal income tax liability rests with the individual owners, who pay taxes at their applicable individual income tax rates.

Electing S Corporation Tax Status

An LLC can choose to be taxed as an S corporation (S-corp) for federal income tax purposes by filing Form 2553 with the IRS. This election is often made to potentially reduce self-employment tax for active owners. While the LLC retains its legal structure, its tax treatment changes to that of an S-corp.

An S-corp owner who actively works in the business can be paid a “reasonable salary,” which is subject to federal payroll taxes. Any remaining profits can then be distributed to the owner as distributions, generally not subject to self-employment taxes.

For tax reporting, an LLC electing S-corp status files Form 1120-S. This form reports the company’s income, gains, losses, deductions, and credits. The S-corp’s income and losses pass through to the owners via Schedule K-1.

Owners report their share of the S-corp’s income or loss on their personal tax returns. The income taxed at the individual level includes both the reasonable salary and the distributions. The IRS requires the salary paid to the owner to be “reasonable,” reflecting fair market value for the services performed.

To qualify for S-corp status, an LLC must meet specific IRS requirements. These include having only U.S. citizens or residents as shareholders, a limited number of shareholders, and only one class of stock. All LLC members must consent to the S-corp election.

Electing C Corporation Tax Status

An LLC can elect to be taxed as a C corporation (C-corp) for federal income tax purposes by filing Form 8832 with the IRS. This choice fundamentally changes how the entity’s profits are taxed.

When an LLC is taxed as a C-corp, it becomes a separate taxable entity. It pays federal income tax on its profits at the corporate tax rate. The LLC files Form 1120 to report its income and calculate its tax liability.

A significant implication of C-corp taxation is “double taxation.” Corporate profits are first taxed at the corporate level. If remaining profits are distributed to shareholders as dividends, those dividends are taxed again at the individual shareholder level. This can reduce the overall amount of profit available to owners compared to pass-through entities.

Despite double taxation, electing C-corp status can be advantageous in certain situations. It may benefit businesses aiming to attract venture capital, as investors often prefer the corporate structure. It can also be beneficial for businesses that plan to retain a significant portion of their earnings for growth and reinvestment, as these retained earnings are only taxed at the corporate level until distributed.

Self-Employment Tax Considerations

Self-employment tax represents the Social Security and Medicare taxes for individuals who work for themselves. This tax supports federal programs for retirement, disability, and healthcare.

For single-member LLC owners taxed by default as sole proprietorships, and for multi-member LLC partners, self-employment tax applies to their entire share of the LLC’s net earnings. This means they are responsible for both the employer and employee portions of Social Security and Medicare taxes. The self-employment tax is calculated on Schedule SE, filed with their personal income tax return.

The self-employment tax rate is generally 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare. The Social Security portion applies to net earnings up to an annual limit, while the Medicare portion applies to all net earnings.

In contrast, an LLC owner who elects S corporation tax status pays self-employment tax only on their reasonable salary, not on their distributions. This can potentially reduce the overall self-employment tax burden on the owner’s total income from the business. The reasonable salary is subject to payroll taxes, which include the Social Security and Medicare components.

Other Taxes Applicable to LLCs

Beyond federal income and self-employment taxes, LLCs are subject to various other taxes at the state and local levels. These obligations can vary significantly depending on the business’s location and activities. It is important for LLC owners to understand these additional tax requirements.

Many states impose their own income taxes on LLC income. In most states, this tax also passes through to the owners’ personal state income tax returns, mirroring the federal pass-through treatment. However, some states may impose entity-level taxes on certain LLCs or partnerships, such as a gross receipts tax or a minimum tax based on income thresholds, which the LLC pays directly.

Franchise taxes or annual fees are common state-specific charges for the privilege of doing business as an LLC within that state. These fees can be a flat amount or tied to factors like gross receipts or net worth. Some states may have an annual minimum tax regardless of profitability, or a tax that increases with income levels.

If an LLC sells taxable goods or services, it is generally responsible for collecting and remitting state and local sales taxes. The specific items and services subject to sales tax, as well as the applicable rates, differ greatly across jurisdictions.

LLCs that have employees, including an S-corp owner receiving a salary, must also handle payroll taxes. These include federal taxes like Social Security, Medicare, and federal unemployment tax, as well as state unemployment insurance. The LLC is responsible for withholding these taxes from employee wages and remitting them to the appropriate tax agencies.

Finally, if an LLC owns real estate or certain types of tangible personal property used in the business, it will be subject to property taxes. These taxes are typically assessed by local governments based on the assessed value of the property.