It is not uncommon to see some confusion arise around how New Mexico LLCs are taxed. A likely cause of this is rooted in the variety of choices LLCs have when it comes to selecting their form of taxation with the IRS. It may also come from misleading claims about what tax benefits are achievable in other states.
A good example of this is when people choose to form an LLC in Nevada or Wyoming simply because they see that neither state has an income tax. In reality, however, most people that form an LLC in those states for that reason will never reap the benefits of the no income tax status. This is because LLCs are typically classified as pass-through entities.
Pass-through taxation takes place when an LLC’s earnings pass directly to the owner. This means that the LLC is not required to file a corporate tax return, rather the owner records the profits and losses on their own individual tax return. In this way, the owners of the LLC avoid the double taxation that corporations experience, in which the income is taxed at both a corporate and individual level.
Because the income is recorded on the owner’s personal tax return, it is subject to the income tax that applies wherever the owner lives. It is for this reason that it doesn’t matter if you form an LLC in a state with no income tax. It is the income tax in the state where you reside that matters.
The IRS has determined that the pass-through classification is the default classification for LLCs. Note, however, that there are a few different forms of the pass-through classification that may apply to your company.
For example, if your company is a single-member LLC, then it is considered a disregarded entity. For tax purposes, a disregarded entity means that the owner of the company is not considered separate of the company. If your company is a multi-member LLC, on the other hand, then it will be treated in the same way as a partnership. Here, your company will not pay taxes but the owners must report the income on their K-1 statements to ensure that honest earnings reporting takes place among the owners.
Apart from these classifications, your LLC also has the option of electing for S-Corporation (S-Corp) taxation. This classification is not to be confused with a C-Corporation (C-Corp). With this pass-through classification the owners of an LLC may be able to save on self-employment taxes. However, before changing your LLC’s classification with the IRS, consult an accountant to learn which is best for your company. It is possible that the right answer changes from year to year, in which case you can submit your change to the IRS.
If you are interested in changing your LLCs default classification, you must submit your change within 75 days of obtaining your Employer Identification Number (EIN). If you submit your change within this timeframe, your change in classification will be applied to your LLC retroactively. If you miss this period, you have the option of changing your LLC’s classification only once every five years. At this point the change cannot be applied retroactively. For S-Corp taxation be sure to use Form 2553. All other entity types should use Form 8832.