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An LLC Taxation Quick Breakdown

An LLC Taxation Quick Breakdown

A Limited Liability Company (LLC) is not recognized by the IRS and is not a separate entity. The IRS calls it a “pass-through entity” because its profits and losses are passed through the business to the LLC members who will then report the required information on their own tax returns. It has the liability protection of a corporation but is a combination of a sole proprietorship or partnership operations. It is also an organization recognized in all states and since it doesn’t have any tax classification, IRS applies the existing tax classifications for this organization. 

An LLC gives limited liability protection to its owners who are taxed under regular tax rates. To put it simply, the income of an LLC company will depend on the number of its members and whether it chooses to be treated as a different form of business which will then be taxed accordingly.

Taxation On Single-Owner LLCs

If you’re a sole owner of your LLC, you will be taxed as a single business owner or a sole proprietor. The IRS will treat one-member LLCs as sole proprietors and will file a tax return on Schedule C. The records of profits and losses of the LLC will be submitted together with your 1040 tax return. Along with the tax return submission, is the payment of self-employment tax base on the LLC’s income. Profits that are left on the company’s bank account every end of the year for business expansion will still be taxed by the IRS. However, the LLC itself doesn't need to pay taxes according to the tax law.

Taxation On Multiple-Owner LLCs

If an LLC has more than one owner will pay taxes as a partnership and still will not pay taxes based on business income. Filing partnership taxes involves filing an information return on Form 1065 transparent of the profit and losses of the partnership. Each partner will be given a tax form on Schedule K-1 that shows his or her own of the partnership’s profit or loss. This distributive share of the partners should have an LLC operating agreement and will be included in the owner’s personal tax filing.

Taxation On LLC’s as Corporations or S Corporations

An LLC can also pay income taxes as a:

  • Corporation. In order for an LLC to be taxed as a Corporation, the IRS Form 8832 must be filed. This becomes an option for the business because it offers lower taxes for individuals with a higher income. Once the LCC established its new tax status, it will start paying tax and will proceed to operate according to its company operating agreement. The taxes of LLC members will change as well once LLC achieved its new status.

  • S Corporation. Paying taxes as an S Corporation is another option for an LLC. The S Corporations owners are allowed to include their business income or losses on their tax returns without having to pay double taxation. Filing for S Corporations is just the same with how LLC members file their taxes and that’s filing a Schedule K-1 as well.

S Corporation and LLC Differences

It’s important that you understand the tax differences between an S Corporation and an LLC before you change your LLC’s tax status. You will be required to meet the requirements by the IRS before you can change the status of your LLC such as the following:

  • It must be a domestic entity legally treated as a corporation
  • Shareholders should be no more than 100
  • Shareholders are limited to individuals, estates, exempt organizations or trusts
  • A December 31 fiscal year-end must be followed

If you’re planning to change your tax status, make sure you consult a tax professional for assistance. They will help you better understand the tax regulations of the IRS and help figure out whether your benefits outweigh the possible costs in any of the above-mentioned status.

State Income Taxation For LLCs

Since there are different means of LLC classification and each state for its state income tax, it is best to take a closer look at the taxation law of those states where your LLC is located. Usually, tax rates are modified or are charged a flat rate under federal (IRS) classification but this is not always the case for other states.

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