How Is an LLC Taxed?

Whether you’ve just formed or are looking to form an LLC, you’re probably wondering how taxes on an LLC work and need some help understanding LLC taxes. By default, an LLC isn’t treated as a separate tax entity like a corporation and is instead treated as a pass-through entity like a sole proprietorship or partnership. However, an LLC also has the option to be taxed as a corporation.

Being taxed as a pass-through entity means that the LLC’s profits and losses pass through to the LLC owners, also called “members,” who will report them on their personal tax returns. Generally, the limited liability company (LLC) itself won’t need to pay federal income taxes. However, some states do have an annual tax or other taxes for LLCs. Keep reading to learn more about LLC taxation and all that it entails.

Taxes on LLCs

Usually, the IRS will treat your LLC as a sole proprietorship if it has only one member or a partnership if it has multiple members. You can also elect to be taxed as an S corporation or a C corporation. 

Filing Requirements

Single-member LLCs don’t have to file a separate federal return for their LLC. The owner reports the LLC income on their personal income tax return (Form 1040). But LLCs with multiple members must file a separate informational federal return for the LLC, Form 1065. Then each LLC member reports their share of the profits on Schedule K-1 and attaches it to their own personal federal tax return.

Although LLCs are taxed as sole proprietorships or general partnerships by default, LLCs also have the option to be taxed as corporations. Some LLC members choose to classify their businesses as an S corporation or a C corporation, which can be advantageous in some cases. In particular, many LLCs elect to be taxed as S corporations because it can save the members money on self-employment taxes. You can learn more on our “What Is an S Corp?” page.

Filing as an S or C corporation requires an LLC to file a separate federal tax return for the business and follow the appropriate corporate filing requirements.

Filing state taxes as an LLC will vary from state to state. Consult a qualified tax professional to make sure you’re following your state’s guidelines.

Single-Member LLC Taxes

By default, single-member LLCs are treated like sole proprietorships for federal income tax purposes, meaning the LLC itself doesn’t pay income tax and doesn’t have to file a return with the IRS. Instead, the sole business owner of the LLC must report all profits and losses for the LLC on their 1040 tax return.

Multi-Member LLC Taxes

Multi-member LLCs are treated like partnerships for tax purposes. Like a single-member LLC, a multi-member LLC would not pay federal income taxes on business income. Instead, the LLC members each pay taxes on their respective share of the profits on their personal income tax returns.

Federal and State LLC Taxes

Typically, LLC profits are “passed through” to members’ personal tax returns at the federal level. However, if an LLC is structured as a C corp, it can be taxed like a corporation at the federal and state corporate tax rate. This setup creates double taxation, where profits are taxed at a corporate level and again at the individual shareholder level.

At the time of this writing, the federal corporate income tax rate is 21%, and individual federal income tax will depend on an individual’s income. In addition to this, most states have an additional corporate tax rate and individual tax rate. 

If you’re operating your LLC as a pass-through entity, you’ll need to look up the personal tax rate in your state for your tax bracket. Also, research any local taxes you would need to pay at the personal level. If you’re having your LLC taxed as a C corporation, you’ll need to look up your state and local corporate tax rate as well as the personal tax rates to see what you’ll owe.

Recommended article: Guide to LLC Tax Filing

Other LLC Tax Considerations

Here are some other things to consider about LLCs and taxes.

Tax Benefits of an LLC

If the LLC isn’t structured as a C corporation, it’s treated as a “pass-through” entity by the IRS. This prevents double taxation because the business itself isn’t taxed on its profits before being distributed to the members. Profits or losses are reported only on members’ personal income taxes.

You have greater control over how you’re taxed with an LLC because you can also opt to be taxed as an S corporation or a C corporation if it works to your advantage. Some LLCs elect S corporation taxation to save on self-employment taxes, while others elect C corporation taxation for the wider range of tax benefits or other benefits. 

You’ll also want to investigate any special write-offs your LLC may be able to claim.

S Corp Status

Even though a traditional LLC already has pass-through taxation, it may still benefit from electing S corp status. It takes a bit of explanation, but it could mean saving thousands of dollars for certain LLCs.

The members of a standard LLC are considered self-employed. They’re compensated by receiving their share of profits from the LLC, but they can’t be employed by the LLC. Being self-employed means paying self-employment taxes (the taxes earmarked for Social Security and Medicare) on all profits they receive from the LLC. This is more than the taxes they’d pay when working for someone else because their employer would pay half of them.

When the members elect S corp status, though, they can be compensated in two ways, by receiving their share of the profits and by being paid as an employee. Once they do that, they only pay those Social Security and Medicare taxes on their salary and not the profits they receive. (Of course, LLC members still must pay income and other applicable taxes on their profits.) This can add up to a lot for certain profitable LLCs. 

One caveat to this is that the IRS expects you to pay yourself a “reasonable salary” as an employee of the LLC. Otherwise, you could pay yourself an annual salary of $1 and avoid contributing anything to Social Security and Medicare. The IRS generally considers “reasonable” to be something similar to what others in your field are earning.

Self-Employment Taxes on an LLC

When it comes to LLCs, understanding self-employment taxes is crucial for members, especially those involved in day-to-day operations. Generally, the IRS treats LLCs as pass-through entities, meaning the business income passes through to the members and is reported on their personal tax returns. Consequently, LLC members are typically subject to self-employment taxes, which cover Social Security and Medicare contributions. As of 2023, the self-employment tax rate is 15.3%, comprising 12.4% for Social Security and 2.9% for Medicare. All net earnings derived from the LLC are subject to these taxes up to the Social Security wage base, after which only the Medicare portion continues without a cap.

However, LLC members can reduce their taxable income through legitimate business deductions, thereby lowering their overall self-employment tax liability. It’s also worth noting that, as mentioned above, LLCs can elect to be taxed as S corporations, potentially altering the self-employment tax obligations by allowing members to be paid as employees.

Recommended article: Self-Employment LLC Taxes Guide

Payroll Taxes for an LLC

For LLCs that elect to hire employees, understanding payroll taxes is an essential aspect of tax compliance. Payroll taxes comprise several components, including Social Security, Medicare, federal income tax, and any applicable state and local taxes. These are withheld from the employees’ wages by the LLC and paid directly to the relevant tax authorities.

As of 2023, the employer is responsible for paying 6.2% for Social Security and 1.45% for Medicare on behalf of each employee, which matches the contributions made through withholdings from employee wages. Additionally, LLCs are responsible for filing quarterly payroll tax reports using IRS Form 941, as well as annual unemployment tax filings using Form 940. It’s important for LLCs to accurately calculate, withhold, and remit these taxes to avoid penalties and interest for late or incorrect payments.

For LLCs treated as disregarded entities or partnerships, members’ earnings are subject to self-employment taxes, but if the LLC elects S corporation status, members can become employees and receive a salary, subjecting that portion of their income to payroll taxes instead. This distinction highlights the importance of understanding the different tax treatments and obligations based on the LLC’s chosen tax classification.

Sales Tax for an LLC

Sales tax represents another crucial tax consideration for LLCs, particularly those that sell goods or services subject to sales tax in their state or locality. The obligation to collect and remit sales tax hinges on the presence of a nexus in the state, which refers to a sufficient physical or economic connection to the state, such as an office, warehouse, or exceeding a certain amount of sales or transactions within the state.

Once a nexus is established, the LLC is responsible for collecting sales tax from customers at the point of sale and subsequently remitting it to the appropriate tax authority. The rate at which sales tax is applied can vary widely depending on the state and local jurisdictions. To comply with sales tax regulations, LLCs must register for a sales tax permit with their state’s tax department, collect the correct amount of sales tax, file sales tax returns, and remit the taxes collected.

Keeping accurate records of sales and taxes collected is essential for ensuring compliance and facilitating the reporting process. For LLCs operating across state lines, understanding and managing sales tax obligations can become complex, often necessitating the use of specialized software or consulting with a tax professional to navigate multi-state sales tax laws.

Try ZenBusiness

If you’re looking to form an LLC of your own or need help navigating its tax situation, consider reaching out to us. We have business formation services and an extensive suite of solutions, including ZenBusiness Money, which helps you track deductions and prepare for tax time. Everything has been carefully designed from the ground up to simplify business operations to help you start, manage, and grow your business.

So while understanding LLC taxation can be complicated, you don’t have to navigate it alone. Get started today by calling 1-844-493-6249 or visiting our Start an LLC page for more info.