Many business owners start with a sole proprietorship and eventually switch to a Limited Liability Company (LLC) for liability protection as they grow. However, moving to an LLC structure also impacts the way you are taxed, in addition to limiting your personal liability.
If you want to pay income taxes for your LLC, you'd perhaps be surprised that the IRS doesn't actually recognize LLCs as an entity. Even though you create and register an LLC with your state, there's no income tax w9 form for an LLC provided by the IRS.
However, that does not mean you don't have to pay any taxes for your LLC. Rather, you get the option to elect how you want to have your LLC taxed.
So, if you own a graphics agency and you're the only one in control, you can opt to have your LLC taxed as a sole proprietorship. If you run the firm with a partner (or multiple partners), you may opt to be taxed as a partnership.
Even if you don't make an election, your LLC is, by default, taxed as sole proprietorship or partnership, depending on the structure of ownership. But that's not all. If getting taxed as a sole proprietorship or partnership doesn't reduce your tax bill, you may elect to file your taxes as a C Corporation or S Corporation instead.
In most states, the LLC owners pay taxes to the state on their personal returns, but the LLC doesn't pay any state tax. However, some states make an exception by charging an LLC a tax based on its income. This is in addition to the tax paid by the owner.
For example, California levies a heavy state tax on LLCs making more than $250,000 annually. So, if you're deciding on a business structure and taxation is one of your concerns (as it should be), speaking to an experienced CPA to learn more about your options can help.
If you are the only member of your LLC, your tax status will be treated as a disregarded entity by the IRS unless you elect otherwise. This means your tax status will look similar to a sole proprietorship, and any profit or loss will be reported on your personal income tax returns (Form 1040).
To submit your tax as a single-member LLC, you'll have to calculate and file your profits (or losses) on Schedule C along with your income tax returns. This amount will be included as income or losses on your personal income tax return Form 1040.
However, if your LLC owns rental properties, you need to file Schedule E instead of Schedule C. Additionally, you'll also be paying self-employment taxes using Schedule SE.
If more than one individual owns the LLC, the default sales tax filing status is a partnership. In this situation, the LLC will file a partnership information return, Form 1065, to report the business' income or losses. Additionally, each LLC member will be given a Schedule K-1 with the income and deductions.
As a partner in a multi-member firm, you'll include the information from your K-1 form on Schedule E as supplemental income to be filed along with your income tax return Form 1040.
Some LLCs may elect to be taxed as C or S Corporations to reduce the tax burden of individual owners. This election may be submitted using IRS Form 8832 - Entity Classification Election. If you make this election, your business structure will remain the same, but the way you pay your taxes will change.
Electing to be taxed as a C corporation means that the company's income and expenses will no longer flow to the owners' individual returns. Therefore, the LLC will get taxed separately from the owners, and it will have to file its own corporate tax returns.
If you choose this option, you will use Form 1120 to report the company's income and expenses to calculate the overall tax liability. You can file Form 1120 online or send it by email, but it's recommended to file using the IRS efile service.
Once you have completed Form 1120, you will know the amount your LLC needs to pay in taxes. Like corporations, you'll also be required to pay quarterly estimated taxes, and you can hire a personalized bookkeeping service to have these taken care of.
An LLC can also opt to pay taxes as an S Corporation by completing and submitting Form 2553 with the IRS. If you make this selection, you will have to file Form 1120S annually to submit your S Corporation tax returns.
Additionally, an S corporation is a pass-through entity, which means it does not pay any taxes itself. All the income and expenses flow through the owners' personal tax returns, and each owner will receive Schedule K-1 to report their supplementary income on Schedule E of Form 1040 and also understand the basics of W4 form which is an Internal Revenue Service (IRS) tax form that is filled out by employees to indicate their tax situation to their employer.
Now, if your LLC is already getting taxed as a pass-through entity, why would you choose this option? Well, the answer is still the same - to lower each individual owner's tax bill. Generally, sole proprietorships and partnerships must pay self-employment tax on 100% of business profits.
On the other hand, S corporation owners only pay self-employment tax on the salary they take from the company. As a result, opting to pay taxes as an S Corporation could considerably reduce the tax liability of high net-worth individuals.
Taxes are an essential consideration while deciding on a business structure for your company. As the IRS doesn't provide a particular tax classification for LLCs, this type of business entity gives you the freedom to select how your LLC will be taxed. Besides the flexibility, the LLC structure may help you save on your tax bill in several ways:
- Avoiding double taxation - Usually, both the corporation and its shareholders pay income tax, leading to double taxation. An LLC is essentially a pass-through entity, which can help you avoid this.
- Save on self-employment tax - Electing to pay as an S Corporation can also help you save on self-employment tax. S corporation owners only pay self-employment tax on their wages. The remaining income is paid to the shareholders as distributions that are not subject to self-employment tax.
- Reducing your tax rate – While choosing your LLC's tax status, it is a good idea to consider the tax rates for disregarded entities and corporations. As a disregarded entity, you will pay tax as a sole proprietor so that the LLC's income is treated as your personal income.
- However, if you choose a corporate status, you may find yourself paying lesser because C corporations are often taxed at a rate lower than individual tax rates.
Depending on how you have elected to pay your taxes as an LLC, you can make use of an online income tax calculator to estimate your company's tax liability. And, if you feel overwhelmed, help is at hand with Fincent's expert bookkeeping services.
We handle all your bookkeeping needs so you can focus on the creative aspects of your business.