By Caron_Beesley, Contributor
Do you operate a single “owner” or member limited liability company (LLC)? Thinking of forming a multi-member LLC? Either way, you’re likely to have questions about how your business is, or will be, taxed.
Here’s what you need to know.
The Basics of Tax Law for LLCs
First, it’s important to understand how an LLC is structured according to tax law. Unlike a corporation, LLCs are not taxed as a separate business entity. Instead, all profits and losses “pass through” the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership. The business does not pay federal income taxes, although some states do apply an annual tax to LLCs.
Depending on the number of members in your LLC, the IRS will treat your business like a sole proprietorship or partnership. However, certain LLCs are automatically classified and taxed as corporations by federal tax law. LLCs not automatically classified as corporations can choose their business entity classification. To do so, an LLC must file Form 8832. Refer to this guide from the IRS for guidelines about how to classify an LLC.
Income Taxes for Single Member LLCs
If you operate single member LLC, then the IRS will treat your business as a sole proprietorship (unless you elect to be a corporation) – meaning that the LLC itself does not pay taxes. Instead, you report all profits and losses of the LLC on your personal income tax return on (Schedule C) and file it with your 1040 tax return.
Get forms and read more from the IRS about single member LLC tax responsibilities. This page also explains when you should file using your social security number and when you should use your Employer Identification Number (EIN).
Income Taxes for Multi-Member LLCs
If your business has multiple owners, the IRS will treat your business as a partnership, unless you elect to be taxed as a corporation (read this blog from SBA guest blogger Barbara Weltman for more on this). Again, the business doesn’t pay taxes, but each owner is taxed on their share of the profits via their personal tax returns (attaching Schedule E). How a multi-member LLC shares profits is defined in the LLC Operating Agreement. Although not required by law in most states, this agreement structures your LLCs financial decisions, including how profits and losses are distributed.
You’ll also need to file Form 1065 (as all partnerships do) with the IRS. This form helps the IRS determine that each member is reporting income correctly. The LLC also must give each partner a Schedule K-1, showing each member’s share of partnership income, credits and deductions. Each member then reports this on their individual Form 1040 and Schedule E. If the LLC is a corporation, it should file Form 1120.
Read more from the IRS about an LLC filing as a corporation or partnership.
If your LLC splits profits and losses in a manner that doesn’t match each member’s percentage interests, you’ll need to request a “special allocation” from the IRS – something you ought to consult about with an accountant or tax lawyer.
Paying Estimated Taxes
LLC owners and members are self-employed and therefore aren’t subject to tax withholding, so each member must pay estimated taxes and self-employment taxes (Medicare and Social Security) quarterly to the IRS and their state tax office. Read more in How To Calculate and Make Estimated Tax Payments.
If you have a multi-member LLC with an owner not actively involved in the LLC (i.e. they invested in the business but don’t participate either through providing services or making management decisions), then that owner may be exempt from paying self-employment taxes. Your accountant or tax lawyer can tell you if your business meets the specific requirements of this exemption.
Sales tax is a point-of-purchase tax imposed by state and local governments. The purchaser pays it and, as a small business owner, you assess it, collect it and pass it on to the appropriate authorities within the prescribed time. Rates and laws vary from state to state, which often leads to confusion, especially if you sell to customers in more than one state. To understand when sales tax applies and how to pay it, read Sales Tax 101 for Small Business Owners and Online Retailers.
If you operate an LLC, you’ll typically pay taxes to your state in the same way you do to the IRS – through your individual returns. Some states charge an LLC tax on income earned by that LLC, on top of the members’ income tax paid. Other states charge an annual LLC fee, unrelated to income, also known as a franchise tax, registration fee, or renewal fee. It’s a good idea to check the tax and business law in your state before you form an LLC.