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What are the tax treatments of LLCs?

On Behalf of | Jan 28, 2022 | Business Formation |

LLCs are usually treated as pass-through entities by the IRS. An LLC itself doesn’t pay taxes, only the people working for it so – the members of the LLC pay taxes on their share of the profits. However, members can decide to pay have the LLC taxed as a corporation instead of a pass-through entity in Texas.

How LLCs pay income taxes

After an LLC business formation, there is a range of taxes the owners are responsible for. Local, state and federal income taxes are the biggest burden on business owners (although in Texas, there are currently no local or state income taxes). How members pay those taxes depends on the type of LLC they have.

Single-member LLC income taxes

A single-member LLC is a disregarded entity for income taxes. A disregarded entity doesn’t have to file a separate income tax return. Sole-owner LLCs list business income and expenses on Form 1040 like a sole proprietor. If the LLC generates income after the business deductions, then the owner would owe taxes based on their IRS personal income rate. The local and state levels work the same as the federal level (again, currently there are no local or state income taxes in Texas).

Multi-member LLC income taxes

Multi-member LLCs are pass-through entities for federal income taxes. Same as a single-member LLC, the LLCs don’t pay taxes. Each member in the LLC pays taxes on the business’s income depending on their ownership stake; each member pays taxes based on their individual tax bracket. If two members have a 50-50 split, then both pay half of the LLC’s profits. Each member files Form 1065 annually. A scheduled K-1 is due by March 15 and explains each member’s ownership. LLC members have to pay into Social Security and Medicare under self-employment taxes.

Which corporate tax status for LLCs

The members of the LLC can vote to for the LLC to be treated as an S-corporation or a C-corporation for tax purposes. To be taxed as a C-corporation, a business can file Form 8832 with the IRS, but some states may need other forms. The LLC will have a 21% federal corporate tax rate (which rate may be changed by the federal government), and members need Form 1120 for the return. To be taxed as an S-corporation, a business can file Form 2553. An S-corporation is still a pass-through entity, so the salary distributes differently before taxes. Members must file Form 1120S for tax returns.

The many types of LLC business formations each have their own rules. Any LLCs should take advantage of available tax deductions and tax credits as well as make sure members get the correct forms when filing. Members need to understand the deadlines and tax brackets for their LLC.