First things first, what is an LLC? LLC stands for Limited Liability Company and these are strictly legal entities set up through the State and are used to protect personal assets. The IRS does not recognize the LLC as an entity, there is no IRS LLC tax form. As an LLC you have the choice to decide how the LLC is taxed. There is no IRS LLC tax form.
You have to keep in mind, even though the IRS does not have an LLC tax form, your state might. Here is California, you also have to keep in mind that if you form an LLC, you will be required to file a separate LLC tax return and pay a minimum franchise tax of $800 every year, regardless if the business is active and making money or not.
Fun Fact: Many well-known companies such as Anheuser-Busch and Blockbuster are structured as LLCs!
Most common choices of taxation for LLCs
The IRS treats single owner LLCs as sole proprietorships, meaning the LLC itself does not submit a return or pay taxes. The owner is responsible for filling out a Schedule C reporting all profits or losses and submitting it to the IRS with the 1040 tax return. Even if profits are left in the company’s account for future purposes, taxes must be paid on all profits.
When a LLC has multiple owners, the LLC can be treated as a partnership for tax purposes. Just like a single owner LLC, the taxes are paid by the owners. Profits are shared and the values are reported on the owner’s tax return. Each owner receives a share on the profits or losses – which is determined beforehand. This agreement is known as a “distributive share” and is included in the LLC operating agreement.
When dividing profits between the LLCs partners, most come to the agreement to split the profit and losses based on their percentage of ownership. For example, if Owner A owns 45% of the company, and Owner B owns 55%, Owner A is entitled to 45% of profits and losses while Owner B is entitled to 55%. If the owners prefer to split the LLCs earnings in a way that is disproportionate to their percentage of ownership, this is called a “special allocation”.
Even if the LLC leaves all profits in the company, each member is required to pay taxes on their share of money. To do so, Form 1065 must be filed with an IRS. Each member is also required to submit a Schedule K-1, and report all their profits and losses on their own Form 1040 with a Schedule E attached.
As a single member or multi member LLC you can elect to be treated as a S-Corporation for tax purposes. Just like a sole proprietorship or partnership, the taxes are paid by the owners. Profits are shared and the values are reported on the owner’s tax return.
The advantage to electing the S-Corporation versus a sole proprietorship or partnership is that you can avoid some of the FICA (social security and Medicare) taxes. Since the S-Corporation’s profits are not subject to the FICA taxes, the IRS does require owners of S-Corporations to run payroll for the owners, so do be aware of this requirement if you decide to elect the S-Corporation tax status.
If the owner(s) of an LLC decide they need to leave a significant amount of profits in the LLC for whatever reason, this is known as “retained earnings.” In this case, the owner(s) would benefit from corporate taxation. In order to be treated as a corporation for tax purposes, the Form 8832 (Entity Classification Election) must be filed with the IRS. Corporate tax rates on the first $75,000 are lower than individual income tax rates, resulting in potential savings.
Additional benefits include the ability to offer owners and employees various tax-related benefits and the ability to offer owners and employees stock and stock ownership options.
Taxes are not withheld for LLC members as they are considered self-employed business owners. It is crucial for owners to be aware of this, as they should know to put away enough to pay the estimated amount of taxes on their share of profits. Payments are made quarterly in April, June, September, and January with both the IRS and State. Check out my YouTube video for info on paying estimated taxes.