How is an LLC taxed?
Dear Jim, The IRS used to get into many disputes with taxpayers on how their entity should be classified for tax purposes. It clogged the court systems, gave taxpayers uncertainty and made attorneys rich. Several years ago, Congress acted to clarify entity selection by using a check-the-box approach. Under entity selection, certain recognized entities are automatically given a default classification. A recognized entity or certain nonrecognized entities, such as those from foreign countries, can choose to be taxed as a different type of entity by completing the check-the-box Form 8832. A limited liability company, or LLC, is an entity formed under state law by filing articles of organization as an LLC. None of the members of an LLC are personally liable for its debts. An LLC may be classified for federal income tax purposes as a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in regulations section 301.7701-3.
At the federal level An LLC may be classified for Federal income tax purposes as a sole proprietorship (referred to as an entity to be disregarded as separate from its owner), partnership or a corporation. If the LLC has only one owner, it will automatically be considered to be a sole proprietorship (referred to as an entity to be disregarded as separate from its owner), unless an election is made to be treated as a corporation. If the LLC has two or more owners, it will automatically be considered to be a partnership unless an election is made to be treated as a corporation. If the LLC does not elect its classification, a default classification of partnership (multi-member LLC) or sole proprietorship (single member LLC) will apply. At the state level – LLC Tax Your LLC may be treated differently for tax purposes then at the federal level. Some states impose an annual tax or attach an additional tax depending upon your LLCs gross receipts.
A state-registered LLC can be taxed for federal income tax purposes as a partnership. Under the check-the-box rules, an LLC can elect partnership status to avoid taxation at the entity level as an “association taxed as a corporation.” If an LLC is not taxed as a partnership, it will be taxed at the entity level similar to a standard or C corporation. The state income tax treatment of LLC profits and losses may or may not mirror the IRS tax treatment depending on the state. For specific information on your state rules visit your state’s web site. The web address can be found on our detailed state information page. Please note that California LLCs are subject to an annual minimum franchise tax of $800 per year. The first payment must be made within 3 months of forming your LLC. The state of California does send a bill to help you to remember to make this payment.
A. One (1) owner LLC’s are treated the same as sole proprietorships for tax purposes. A member of an LLC will report profits on Schedule C as part of the member’s individual 1040 tax return. Self-employment taxes on LLC net income must be paid just as you would with any self-employment business. Multiple owner LLC’s can elect on the SS-4 form to be treated as a partnership by the IRS. (Note: Nevada, L.L.C. can prepare and file the SS-4 form for you). The tax return that the LLC completes and files is IRS Form 1065, Partnership Information Return. On this form, LLC profits are reported and allocated to each of the owners according to the LLC’s operating agreement. Each owner is given a Schedule K-1, which shows each owner’s share of LLC income or loss. The owner then reports and pays taxes on this income on the owner’s annual 1040 income tax return. There is a possible third tax treatment that an LLC could elect if it does not want pass-through taxation.
A single-member LLC is taxed like a sole-proprietorship. This means that they pay a “self-employment” tax and simply add any income onto their 1040 personal tax return. An LLC with 2 or more members is taxed like a partnership where each partner adds their portion of income onto their 1040 personal tax returns. The LLC must also file an informational return showing all the members and their income on form 1065. An interesting aspect of an LLC is that it can file a form with the IRS and elect to be taxed like a corporation by filing IRS Form 8832. However, this is fairly rare for small businesses.
