Types of LLCs
Unlike a corporation, an LLC is a pass-through business entity. This means that profits and losses pass through the members, or owners, of the LLC via their personal taxes.
Single-owner LLCs are taxed like sole proprietorships. These types of LLCs don’t require any special IRS forms. Instead, business owners pass their information through their Schedule C of the 1040 tax form, and they must pay income tax on all income from the business.
For partnerships, also known as multi-owner LLCs, distributive shares apply. This means that each owner pays for their share of the profits and losses through Schedule E of the 1040 tax form. In addition to that, multi-owner LLCs file Form 1065, the U.S Return of Partnership Income, which the IRS uses to ensure that the partners are reporting their money correctly.
Distributive share for taxes with LLC partnerships
The percentage each partner owns determines the profits for which they are taxed. If Partner A owns 55% and Partner B owns 45%, that is their distributive share. If the profits and losses need to be split differently than the ownership percentages, that’s called a special allocation, which has a host of compliance rules.
Though the shares are a piece of the company’s financial pie, the IRS sees it as the whole when it comes to assessing taxes. This means that even if members have not received their profit share from the business, they are still legally liable for the taxes on their slice.
Why choose corporate taxes with LLC
Retained earnings are earnings that are held by the company and not paid out as dividends to shareholders. LLCs that regularly retain their earnings may elect to be taxed as a corporation. As of 2018, C corporations are taxed at a flat rate of 21%, which is lower than regular income tax rates of between 32 and 37%. In addition to the lower rate, LLCs with retained earnings are not subject to double taxation, which is where a corporation pays its 21% tax and then shareholders must also pay income tax on their capital gains.
Self-employment taxation rules
LLC owners are considered self-employed, so they aren’t subject to the same Social Security and Medicare withholdings but are subject to self-employment taxes. Active members must file a Schedule SE form with the amount of taxes due. This is submitted with their annual tax returns. If an LLC has employees, the self-employment tax of LLC owners doubles because they have to match the contributions of regular employees. However, members can deduct up to half of their taxable income, which provides some tax savings.
The self-employed tax rate for 2021 is 15.3%. This rate is a combination of 12.4% for Social Security and 2.9% for Medicare for up to $142,800 in earnings. Earnings beyond that threshold garner a 0.9% rate.
LLC members who are passive, meaning they invested money but aren’t responsible for making management decisions or otherwise running the business, don’t have to pay self-employment taxes on their shares.
Expenses and write-offs
An LLC can deduct most business expenses, including advertising, travel and automobile costs. Thanks to the 2017 Tax Cuts and Jobs Act, members of a single or partner LLCs that don’t elect to be taxed as a C corporation may deduct up to 20% of the company’s net income from their personal income taxes. For example, if their LLC earns $1,000, they can deduct $200 from their personal taxes.
When it comes to LLCs with employees, the amount paid to employees and the depreciable properties play key roles in determining the write-off amounts. With the help of a qualified tax professional, you can find the best path for your business.
How is an LLC taxed by states?
Along with the IRS, some businesses have to consider state taxation rules for their LLC profits as it applies to their personal returns. California, for example, is one of the most tax-intensive states for LLCs. It levies tax on LLCs making more than $250,000 annually in addition to a minimum annual registration fee, also called a franchise tax , of about $800 after the company’s first year of business. Some states charge this flat fee regardless of revenue. Wyoming and South Dakota are two of the friendliest states for LLC taxes as they have neither corporate nor income taxes.
When thinking of establishing an LLC, it’s a good idea to choose your structure wisely and also understand your income and state tax expectations so you can be better prepared.
