If you operate your business using a limited liability company (LLC), then you have more flexibility in choosing how the IRS taxes your business earnings. Your choice will directly influence the tax filing rules you are subject to. There is no set of tax rules that specifically apply to LLCs; the IRS allows the LLC to use partnership, corporate or sole proprietor tax rules.
Key Takeaways
- If you’re the single member of a limited liability company (LLC), you’ll typically file your business tax information on Schedule C and report the profit or loss from your business on Form 1040.
- If you elect to be taxed as a partnership, you’ll prepare annual partnership tax returns using IRS Form 1065, but all income, deductions and credits are passed-through to the owners and reported on their own tax returns.
- If you elect to be taxed as a corporation by filing IRS Form 8832, the default is to be treated as a C-Corporation. In this case, the business reports all income and deductions on Form 1120 each year and pays the corresponding income tax.
- You can choose to be treated as an S-Corporation for tax purposes. This passes-through the business' income to the owners on a Schedule K-1.
IRS default designations
The IRS mostly ignores LLCs for tax purposes and considers two or more people or businesses working together in a trade or business to be a partnership for tax purposes. However, if you are the sole owner of an LLC, then the IRS "disregards" your LLC and considers you a sole proprietor. LLCs can be formed under state law and then elect how to be treated for federal taxes.
If you prefer the tax filing rules of a corporation to partnership or sole proprietorship taxation, then you have the option to elect corporate tax treatment by filing IRS Form 8832. Once you make this election, you typically cannot change to another tax designation again for five years.
Partnership filing requirements
LLCs that are subject to the partnership tax rules don't actually pay tax on their business earnings, but instead are responsible for preparing annual partnership tax returns using IRS Form 1065. This tax return is mostly for informational purposes; all income, deductions and credits are passed-through to the owners and reported on their own tax returns.
The LLC reports each owner's share of these amounts on a Schedule K-1 at the end of the year. For example, if you and a friend create an LLC to run a business that taxed as a partnership, earns $100,000 and has $60,000 of deductible business expenses, then each of you will receive a Schedule K-1 with $20,000 of net income. Both of you must then report this on your personal income tax returns. Essentially, the business will increase your personal taxable income by $20,000 each.
TurboTax Tip:
A member of an LLC can face double taxation when the LLC files a corporate tax return, pays tax on the income, and distributes its profits to its owners. The tax law considers these distributions to be dividend payments, which are taxable. So the corporation pays taxes on the money, and then the money is taxed again as dividend income on the owners' tax returns.
Corporate filing requirements
If the LLC elects to be tax as a corporation. The default is to be treated as a C-Corporation. In this case, the IRS will treat your business as a separate taxpayer in the same way you are a separate taxpayer from your friend. As a result, the business reports all income and deductions on Form 1120 each year and pays the corresponding income tax.
An entity classified as a corporation can elect to be treat as an S-Corporation for tax purposes. As with the partnership tax filing for LLCs above, making an election to be taxed as an S-Corp instead of as a C-Corp passes-through the business' income to the owners on a K-1. S-Corps use Form 1120S to file their taxes and no federal tax is paid at the corporate level.
Many LLCs choose to be taxed as one of the pass-through entities rather than as a C-Corps to avoid possible double taxation. The first level of tax occurs when the LLC files a corporate tax return and pays tax, and the second can happen if the corporation distributes its profits to its owners. The tax law considers these distributions to be dividend payments. Dividends are typically taxable to owners. But, the corporation does not get to take a tax deduction for the payment of the dividends. So the corporation pays taxes on the money and then the money is taxed again as dividend income on the owners' tax returns.
Single Member LLC filing requirements
Single member LLCs are typically treated the same as sole proprietorships. The IRS disregards the LLC entity as being separate and distinct from the owner. Essentially, this means that the LLC typically files the business tax information with your personal tax returns on Schedule C. The profit or loss from your businesses is included with the other income your report on Form 1040.
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FAQs
It is advisable to consult an accountant before electing to pay taxes as a corporation. An LLC can file as a C corp by filing Form 8832, Entity Classification Election, with the IRS. Corporate taxation is complicated, and it's a good idea to consult an accountant before paying business taxes as a corporation.
How to maximize tax deductions for LLC? ›
To gain the maximum tax benefit, your LLC will need to file taxes as an S Corp. This will help you reduce your self-employment taxes by paying yourself a salary from a portion of the revenue and distributing the rest of the money earned by the business as a dividend.
How do LLCs avoid paying taxes twice? ›
An LLC can avoid double taxation by electing to be taxed as a pass-through entity. If the LLC has just one member, that owner can choose to be taxed as either a disregarded entity ( and pay business tax on their individual return) or an S Corporation to avoid double taxation.
How much can an LLC write off? ›
The Qualified Business Income (QBI) deduction, or Section 199A deduction, is another deduction available to eligible pass-through entities such as an LLC or S corp. The QBI deduction is up to 20% depending on total taxable income, and can be taken in addition to standard and itemized deductions.
What is the most tax efficient way to pay yourself in an LLC? ›
One of the most advantageous ways to get paid from your LLC is as a W-2 employee. Using this method, you will receive a regular paycheck as would an employee of any business. This is a good way to have a predictable income for your personal finances.
What are the cons of an LLC tax? ›
One significant downside of forming an LLC pertains to self-employment taxes. Those who are members of an LLC fall into the category of being self-employed, which obligates them to shoulder the costs associated with federal services such as Social Security and Medicare through self-employment taxes.
How do LLC owners avoid taxes? ›
The key concept associated with the taxation of an LLC is pass-through. This describes the way the LLC's earnings can be passed straight through to the owner or owners, without having to pay corporate federal income taxes first. Sole proprietorships and partnerships also pay taxes as pass-through entities.
How much should an LLC put away for taxes? ›
About 30-40% of your net income. This is a reliable rule of thumb because, on average small business owners make $66,000 or less, putting them into the 22% tax bracket or below. Add that to the 15.3% federal self-employment tax, and you're probably right in the middle of that range.
Can you write off car payments for LLC? ›
Yes, an LLC can write off a car purchase as long as it is used for business purposes. The exact amount of the deduction will depend on whether you use the standard mileage rate or the actual expense method.
Do I file LLC and personal taxes together? ›
Can I File My LLC and Personal Taxes Separately? Yes, if your LLC is considered a corporation, then these taxes can be filed separately from your personal taxes. If your LLC is not considered a corporation, the taxes are to be filed with your personal taxes.
Simply put, yes, you can have an LLC with no income, but that still has expenses. An LLC with no income but deductible expenses can offset future income through a net operating loss deduction. However, the IRS will still regard this as business activity, so it must be reported yearly.
Can the IRS go after my LLC? ›
The sooner you pay off your debt, the sooner you can apply your profits to re-investing in your business. Thankfully the separation created by forming an LLC will keep the IRS and your state tax authority from being able to garnish the LLC's assets or those of your other members.
Can an LLC write-off mortgage payments? ›
"Yes, but it is limited and the treatment depends on how the LLC is taxed," says Crystal Stranger, Partner and Chief Operating Officer at Cleer Tax & Bookkeeping. "If [the LLC is taxed as] a sole proprietorship, [mortgage interest can be deducted on Schedule E" of Form 1040, she explains.
How does an LLC affect my personal taxes? ›
Single member LLCs are typically treated the same as sole proprietorships. The IRS disregards the LLC entity as being separate and distinct from the owner. Essentially, this means that the LLC typically files the business tax information with your personal tax returns on Schedule C.
What is the first year write-off for LLC? ›
According to the IRS Tax Code, you may deduct up to $5,000 of startup costs in your first year.
Can IRS come after an LLC for personal taxes? ›
Possible Garnishment
Thankfully the separation created by forming an LLC will keep the IRS and your state tax authority from being able to garnish the LLC's assets or those of your other members.
Do you pay taxes if your LLC doesn't make money? ›
Besides paying taxes, proper record-keeping, documentation, and filing are essential for accountability. Therefore, your limited liability company should still file tax returns even if you didn't make any money. A good rule of thumb is always to file taxes whenever you're confused.
Can I file LLC taxes on TurboTax? ›
If it's a single-member LLC, it's a disregarded for federal income tax purposes and you can use any desktop version of TurboTax or TurboTax Premium Self-Employed if you want to prepare your return online.
Does a single member LLC file a separate tax return? ›
For income tax purposes, an LLC with only one member is treated as an entity disregarded as separate from its owner, unless it files Form 8832 and elects to be treated as a corporation. However, for purposes of employment tax and certain excise taxes, an LLC with only one member is still considered a separate entity.
