There are a number of legal entities used to form a business, each with its own benefits and limitations. In recent years, a popular choice has been the Limited Liability Company (LLC).
The LLC combines the liability protection to the business owner(s) provided by a C Corporation with certain tax benefits not available to other types of entities such as a Sole Proprietorship or Partnership.
LLCs are generally easier to set up and maintain than a C Corporation. To form an LLC, you file articles of organization under state law. LLCs can have just one member, two members, or unlimited members.
How Are LLCs Taxed?
One of the unique aspects of an LLC is the ability to choose its tax treatment.
The IRS and other entities tax an LLC as a partnership [link to Partnership blog] if it has more than one member unless it elects to pay taxes as one of the following:
- An LLC can be <taxed as a C Corporation> using Form 8832.
- An LLC can be <taxed as an S Corporation> using Form 8832 and Form 2553.
- An LLC can be <taxed as a Sole-Proprietorship> if there is only one member (known as a Single Member LLC or a “disregarded entity not separate from its owner”). No form is required.
Once you choose a tax designation, it must remain in effect for five years before being changed (without approval from the IRS).
What Tax Form Does an LLC File?
An LLC does not have its own tax form. It will file the tax return on the due date (including any extension) associated with the tax election it has made.
- If <taxed as a Partnership> – Form 1065.
- If <taxed as a C Corporation> – Form 1120.
- If <taxed as an S Corporation> – Form 1120S.
- If <taxed as a Sole Proprietor> – Schedule C of Form 1040.
Estimated Taxes and Payroll Taxes of an LLC
The chosen tax treatment of an LLC determines its estimated taxes.
Any employee of an LLC that receives salaries, wages, or other compensation is subject to federal and state (if applicable) payroll taxes. It is the LLC’s responsibility to withhold these taxes, match any required by law, and remit these amounts to the appropriate taxing agency on a timely basis.
It is crucial not to ignore payroll taxes. They can be a significant cost of doing business with potential ramifications to cash flow.
Understanding and fulfilling tax obligations is paramount for every business operator. Taxes are a substantial business expense and neglecting them can lead to severe consequences. It is crucial to consult with a qualified tax expert, such as a Certified Public Accountant (CPA), to navigate your specific tax requirements.
How are distributions from an LLC taxed?
In general, distributions from an LLC are not taxed but are dependent on the tax treatment selected.
For an LLC taxed as a Sole Proprietor, distributions are never taxed.
For an LLC taxed as a Partnership or an S-Corporation, distributions are not taxed unless they are in excess of the investment and prior year profits or losses (also known as basis) of the member. This is a very complicated topic and, again, a CPA should be consulted.
What are the tax advantages of an LLC?
The only tax advantage of an LLC is if it has elected tax treatment as an S-Corporation. The other LLC entities will cause the members to be subject to Social Security (to a certain limit) and Medicare (unlimited) taxes on any profit (self-employment income) of the business. Election to be taxed as an S-Corporation minimizes this as the profit from an S-Corporation is not self-employment income and therefore not subject to those taxes.
However, the Internal Revenue Service does require owners of an LLC taxed as an S-Corporation to take a reasonable salary which will be subject to Social Security and Medicare.
This is also a complicated, but potentially beneficial situation that a CPA can make easy.