Whether you’re an individual or an LLC, taxes are complicated and just downright frustrating!
There are so many rules and regulations, “if’s”, “and’s”, and “but’s” to follow that it’s truly hard to determine if an LLC is better for taxes or how much taxes you have to pay on your LLC.
In this article, we’ll cover a variety of LLC taxes, how they work, and how you can help reduce your tax bill. Understanding how to structure your business can help you make better financial decisions for years to come.
What is an LLC?
A limited liability company (LLC) is a business structure in the United States whereby the owners are not personally liable for the company's debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.
LLCs are the most common business entity used because they can run almost any type of business. Any person starting a business, or currently running, should consider forming an LLC due to limiting their personal legal liability as much as possible.
How are Limited Liability Companies Taxed?
A Limited Liability Company (LLC) is not a separate tax entity like a corporation; instead, it is what the IRS calls a “pass-through entity,” like a partnership or sole proprietorship.
This means that the LLC itself doesn’t pay taxes on business income. Instead, the members of the LLC pay taxes on their share of the LLC’s profits. Members can also choose for the LLC to be taxed as a corporation instead of a pass-through entity.
There are several types of LLC taxes – all imposed by the federal, state, and local governments. All LLC members are responsible for paying income tax on any income they earn from the LLC as well as self-employment taxes. Depending on what you sell and whether you have employees, you might also be responsible for paying payroll taxes and sales taxes. Depending on your situation, an LLC can also opt to be taxed as a different business entity.
In addition to paying income taxes based on your business income, LLC members are typically considered to be self-employed, therefore they must pay self-employment tax on their income. This is to cover Social Security and Medicare – a tax called FICA tax.
If your LLC chooses to be taxed as a corporation, corporate tax rules will apply. That means the corporation itself is taxed. The corporation pays income tax on its net earnings and the owners/members pay income tax on any dividends they receive.
If your LLC chooses to be taxed as an S corporation, members don't have to pay self-employment tax because S corporation owners aren't considered to be self-employed.
Depending on how you choose to set your business structure, there are several taxes that your LLC may be responsible for. Remember, federal, state, and local income taxes are all imposed on LLCs, so it’s often one of the biggest stressors of members. The way in which you file and pay income taxes as an LLC depends on whether you have one owner or multiple owners.
How are Single Member LLC Taxed?
Single member LLCs are taxed just like sole proprietorships, meaning the business itself does not pay taxes or have to file a tax return.
As the one and only owner of the LLC, you’ll report business income and expenses on Form 1040, Schedule C. As explained by CPAs, “If, after deducting business expenses, the LLC generates a profit for the year, the owner will owe taxes to the IRS in accordance with their personal income tax rate.” They also explain that if the LLC operates at a loss for the year, you can deduct the business’s losses from your personal income.
How are Multi Member LLCs Taxed?
Multi-member LLCs are treated the same as partnerships and taxes similar to single member LLCs. Multi member LLC members must each file their own personal tax return claiming their share of the profits.
The business itself does not have to file a tax return with the IRS.
For example, if two members have a 50-50 split ownership, each is responsible for paying taxes on half of the business’s profits. Like a partnership, each owner can also claim half of the tax deductions and tax credits that the LLC is eligible for and write off half of the losses.
Multi-member LLCs must file certain tax forms with the IRS, including Form 1065, U.S. Return of Partnership Income. The LLC must also give each owner a completed Schedule K-1 (a summary of each owner’s share, plus the income, losses, and deductions) by March 15 of each year. Each owner will then attach their Schedule K-1 to their personal income tax return that’s filed with the IRS.
Electing Taxation for Your Texas LLC
As if taxes were not complicated and stressful enough, there are ways to make things more complicated. Members of an LLC can also elect for the business to classify as a C Corp or S Corp for tax purposes. This change should be made in the beginning when your Operating Agreement is formed and filed.
Legally, choosing a corporate taxation will not affect your LLC. The changes are made to income because it’s taxed differently when filed as a corporation rather than an LLC. Plus, a corporation is eligible for more credits and deductions.
Should LLCs consider corporate taxation? Many LLCs choose to be taxed as corporations to save on taxes. This is best suited for really profitable LLCs and those that will benefit from not having to pay self-employment taxes.
What is Tax Deductible for an LLC?
One of the many advantages of forming an LLC are the many items that are tax deductible. Here are just a few:
- Health benefits
- Auto expenses
- Capital expenses (starting your business)
- Legal and professional fees
- Advertising and marketing
- Business gifts
- Credit card fees
- Bank fees
How LLCs Pay State income Tax in Texas
Once you’ve chosen your LLC tax status, your state’s department of revenue will tell you how your LLC will be taxed. There are two factors to look at:
- How does the LLC classification – sole proprietor, partnership or corporation – affect the state income?
- What is the tax in Texas based on?
In Texas, the income tax is called a franchise tax, and 90% of Texas LLCs don’t have to pay this tax. If your LLC is below the “No Tax Due” threshold – which is reported to be $1,180,000 in 2020 – then you will not have to pay a franchise tax either!
Remember, even if you do not owe taxes, you still have to file a No Tax Due Report and a Public Information Report.