Limited liability companies are businesses formed in the United States that provide the owners limited liability protection. Forming an LLC also provides certain tax benefits, where owners (known as members) are taxed at their own personal tax rates.
Although there are various methods of electing taxation for an LLC, this also depends on how many members exist in the organization. It will also depend on whether the LLC elects to be treated as a different type of business for tax purposes.
How are Limited Liability Companies Taxed?
Because the Internal Revenue Service (IRS) does not recognize LLCs for tax purposes, it means that an LLC is not a separate tax entity. Instead, LLCs are what is called a “pass-through entity.” This is similar to how a partnership or sole proprietorship is taxed.
Single Owner LLCs
When an LLC only has one member it is treated as a sole proprietorship for tax purposes. This means that the LLC will not pay taxes by itself. Instead, as a single member of an LLC, you will file any income from the LLC, on your personal tax returns. The LLC itself does not have to file a return with the IRS.
You will need to take all of the information from the LLC's income and expenses. Then, take the net income and prepare a Schedule C. This is then brought over to the member’s personal tax return using Form 1040 or 1040-SR.
Multi Owner LLCs
The IRS treats co-owned LLCs as partnerships for tax purposes. Similar to single-member LLCs, multi-member LLCs do not pay taxes on business income. Multi-member LLCs will pay taxes only on their own share of the profits. This will be included in their personal income tax returns.
The process of reporting income is as follows:
- File an information return with the IRS on Form 1065.
- Receive a Schedule K-1 that is prepared for each partner. This will show your share of the profit or loss of the partnership.
- The Schedule K-1 will break down your income into different types. Each type of income goes in a specific place on Schedule E.
- Transfer Schedule K-1 information to Schedule E (Supplemental income).
- Take the information from Schedule E, and place it into the right place on your Form 1040 or 1040-SR.
Should an LLC elect to be Taxed as a Corporation?
LLCs can elect taxation as a corporation or S corp. This is typically a selection only when it results in lower taxes for high-income individuals. The election can be submitted through IRS Form 8832 (Entity Classification Election). This will not change how you operate your business, but it will change how you pay taxes.
Taxation as a Corporation
All “C” corporations are taxed at a flat 21% rate. This is lower than the top three individual income tax rates, which range from 32% to 37%. This means that some LLC owners can save money on their overall taxes by choosing to be taxed as a C corporation. Despite this, any income made from a C corporation is subject to double taxation.
This means that the first 21% corporate tax must be paid from the income of the corporation, and then the shareholders must pay individual income tax on their own portions, which can range up to 23.8%.
Taxation as an S Corp
If you elect to be taxed as an S corp then you are able to avoid taxation. There are a few requirements to be taxed as an S corp, which means not every LLC has this option.
- All members must be U.S residents
- Must have no more than 100 shareholders
- Has only one class of stock
Delaware LLC Deductible Expenses
There are various expenses that are tax-deductible for an LLC. This means that these costs can be subtracted from the overall taxed income of an LLC.
- Rental expenses
- Charitable giving
- Insurance costs
- Tangible property
- Professional expenses
- Meals and entertainment
- Independent contractors
- Cost of goods sold
Other LLC Taxes
All Delaware LLCs are pass-through entities. This means that they are not required to pay federal or state income tax. LLCs in Delaware are required to pay a flat annual tax of $250 to the state.
Self Employment Taxes
LLC members are not employees. This means that because there are no contributions to the Social Security and Medicare systems already withheld, LLC owners must pay "self-employment taxes." These are paid directly to the IRS.
Each owner who is subject to the self-employment tax will report the amount due on Schedule SE. This will then be submitted with their personal tax return. LLC owners, sole proprietors, and partners pay twice as much self-employment tax as regular employees. This is because regular employees have their employers match their contributions to the self-employment tax.
The self-employment tax rate for business owners is 15.3% of all net income up to an annual threshold. After that, the rate is 2.9% for income above the threshold.
How LLC’s Pay State Income Tax
Delaware taxes LLC profits the same way the IRS does. The LLC owners will pay taxes to the state on their personal returns, but the LLC itself does not pay a state tax. Unless taxed as a corporation, LLCs always pass through their profits to the owners, where the owners will pay taxes through their personal tax return.