What Percentage Does an LLC Pay in Taxes?

A Limited Liability Company (LLC) is a popular business structure, offering liability protection that shields owners’ personal assets from business debts and legal claims. Its tax treatment is highly adaptable, often surprising new business owners. Unlike some other business forms, an LLC does not have a single, predetermined tax percentage it must pay. Instead, its tax obligations depend entirely on how the owners choose for the entity to be classified for federal income tax purposes, as well as the specific tax regulations in the jurisdictions where it operates.

Understanding Default Federal Taxation

By default, the Internal Revenue Service (IRS) does not tax an LLC as a separate entity for federal income tax purposes. Instead, the LLC’s income “passes through” to its owners, meaning the LLC itself does not pay federal income tax on its profits.

For an LLC with a single owner, the IRS treats it as a “disregarded entity,” taxing it as a sole proprietorship. The business’s income and expenses are reported directly on the owner’s personal income tax return on Schedule C (Form 1040), Profit or Loss from Business. The net earnings are then subject to self-employment taxes, which fund Social Security and Medicare. This tax applies to 92.35% of net earnings from self-employment, with a combined rate of 15.3% for Social Security (12.4% on earnings up to an annual limit) and Medicare (2.9% on all net earnings).

When an LLC has multiple owners, the IRS generally classifies it as a partnership for federal tax purposes. The LLC must file an informational return, Form 1065, U.S. Return of Partnership Income, to report its income, deductions, gains, and losses. The LLC then issues a Schedule K-1 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc., to each member, detailing their share of the LLC’s profits or losses. Each member includes this information on their personal Form 1040, U.S. Individual Income Tax Return. Multi-member LLC owners also pay self-employment taxes on their share of the net earnings.

Owners are responsible for making estimated tax payments throughout the year to cover their income and self-employment tax liabilities. These payments are typically made quarterly using Form 1040-ES, Estimated Tax for Individuals, to avoid penalties for underpayment.

Electing Alternative Federal Tax Treatment

An LLC can elect alternative federal tax treatment, departing from its default classification. This allows owners to optimize their tax burden, particularly regarding self-employment taxes or corporate income rates. The two primary alternatives are taxation as an S-corporation or a C-corporation.

Electing S-corporation status is a popular choice for many LLC owners seeking to reduce their self-employment tax burden. To make this election, the LLC must file Form 2553, Election by a Small Business Corporation, with the IRS. Under this election, active owner-employees must pay themselves a “reasonable salary” for their services. This salary is subject to regular payroll taxes, including Social Security and Medicare contributions.

Any remaining profits distributed to owners beyond their reasonable salary are generally classified as distributions, not wages, and are therefore not subject to self-employment taxes. This distinction can lead to significant tax savings for profitable LLCs. An LLC taxed as an S-corporation files Form 1120-S, U.S. Income Tax Return for an S Corporation, and issues Schedule K-1s to its shareholders, similar to a partnership. While the S-corporation files an income tax return, it remains a pass-through entity, with income and losses reported on owners’ personal tax returns.

Alternatively, an LLC can elect to be taxed as a C-corporation, which fundamentally changes its federal tax treatment. This election treats the LLC as a separate taxable entity by the IRS, distinct from its owners. The LLC, now taxed as a C-corporation, files Form 1120, U.S. Corporation Income Tax Return, and pays federal corporate income tax on its profits at the corporate tax rate. The corporate tax rate is a flat 21% of taxable income under current federal law.

A significant implication of C-corporation taxation is “double taxation.” Profits are first taxed at the corporate level. Then, if any after-tax profits are distributed to shareholders as dividends, those dividends are taxed again at the individual shareholder level as personal income. Despite this, some LLCs might consider this election for reasons such as retaining earnings for significant growth, attracting venture capital investors who prefer corporate structures, or taking advantage of certain employee benefit plans unavailable to pass-through entities.

State and Local Tax Considerations

Beyond federal income taxes, an LLC’s overall tax burden is significantly shaped by state and local taxes, which vary considerably across jurisdictions. Federal tax classifications often influence how states levy income taxes on LLCs. States typically tax LLCs based on their federal election, imposing personal income tax on owners of pass-through entities (sole proprietorship or partnership), or state corporate income tax if the LLC elects C-corporation status. Some states may also have specific rules or alternative tax calculations for LLCs, regardless of federal classification.

Many states impose specific fees and taxes directly on LLCs, irrespective of their income. Franchise taxes or privilege taxes are levied by some states, such as Texas and California, for the privilege of doing business in the state. These taxes can be based on various factors, including gross receipts, net worth, or a flat fee, and they must be paid regardless of whether the LLC is profitable.

Nearly all states require LLCs to pay an annual report or registration fee to maintain active status. These fees are typically flat amounts, ranging from approximately $25 to $500 annually, depending on the state. Some states also impose gross receipts taxes on businesses, such as Ohio’s Commercial Activity Tax (CAT), which applies to businesses with a certain level of taxable gross receipts from activities in the state.

Local taxes further contribute to an LLC’s total tax obligations. Common local taxes include general business licenses, often required to operate legally within a city or county. Tangible personal property taxes may also apply to business assets like equipment, furniture, and inventory. If an LLC sells goods or services subject to sales tax, it is responsible for collecting and remitting these taxes to the appropriate state and local authorities.