Finance

How an LLC Gets Taxed

According to the IRS, LLCs are pass-through tax entities, meaning that its tax liabilities pass through to the personal income tax of its owners after they form an LLC. On the other hand, C corporation and S corporation are required to pay corporate tax and the tax on the share of net profit owned by the shareholders respectively. In case of the former, there is always a scope of double taxation due to the possibility of the profit being distributed among owners in the form of dividends. Considering these aspects, it becomes obvious as to why LLCs are the preferred form of incorporation chosen by a majority of business owners.

LLCs offer a flexible tax structure which is simple and easy to understand. In addition, they also provide the option to make choice among proprietorship, partnership or C corporation. All one needs to do is file the appropriate tax forms with the IRS. The manner of taxation and some other important topics related to LLCs that often cloud the minds of its owners are discussed below.

How Will the IRS Tax Your LLC if You Do Not Do Anything?

The IRS will put your LLC into a category depending on the number of members as either sole proprietorship or partnership. If you happen to be the only member of the LLC, it will be treated as a sole proprietorship but if there your LLC has another member or more members, the IRS will consider it as a partnership. Thereafter, you will be required to pay the taxes based on the profit earned by you and other owners (if any) on 1040 tax return.

What Forms Do You Need to File?

One of the important requirements for forming an LLC is to have an Operating Agreement. It is essentially an agreement between the owners or members of an LLC which describes the business structure, and more importantly, the tax structure. While some states mandate the filing of Operating Agreement, other states do not necessitate the same. Check thoroughly as to whether or not is necessary to file the operating agreement.

The next step is to file Form 1065 with the IRS and give a Schedule K-1 to each member so that they have a written record of their share of profit and loss. Past that, the LLC members will be taxed on their 1040 tax return.

How Can You Change Your LLC Tax Identity?

Despite the favorable features of LLCs, some entities choose to be taxed as either C corporation or S corporation. Of course, it depends on the business needs of the company. The reason for such a choice is the desire to retain a hefty profit, especially when a multi-member LLC is involved in an active business. In order to apply for the recognition of the tax structure of an LLC as C corporation or S corporation, the applicants are required to file IRS Form 8832 and IRS Form 2553 respectively. In case of the latter, it is also essential to meet the criteria stated by the IRS to maintain the status of S corporation legally.

Other Aspects You Need to Know

It is important to bear in mind certain other aspects. They are as follows:

  1. Remember to set a part of your profit aside for paying the tax as you may prefer not to mention the earnings in your tax return.
  2. Taxes like Medicare taxes and Social Security taxes need not be taken out on a paycheck to paycheck basis.
  3. Lastly, always keep in mind that after you form an LLC, the manner of taxing it varies from one state to another in the United States, so do not forget to consult an experienced attorney or accountant who knows the ins and outs of the rules associated with the taxation of LLCs in your state.