Running your small business can seem romantic. You’re making a living from selling a product you believe in or a service you provide. But on top of all that there are a number of different tasks to do behind the scenes to make sure your business works. One of those things is making sure you’re saving the appropriate amount for your taxes and paying them off. In this article, we’ll explain some things you need to know about taxes related to operating an LLC so you can avoid some dangerous mistakes when filing your business taxes.
First, what is an LLC?
An LLC is a structure you can register your business under which relieves stakeholders of the company’s liabilities and debts. Opening a business bank account for your LLC helps to prove the business and the owner/owners are separate entities. This is important because it lets you keep your personal taxes and business taxes separate, makes your bookkeeping easier, and provides added protection in case of any legal liability.
What are LLC Taxes and How do they work?
The IRS treats LLCs as they would a sole proprietorship or a general partnership for tax purposes depending on how many owners the LLC has. An LLC with only one member or owner does not have to pay taxes or file returns. Instead, the owner reports all profits and losses on a Schedule C and includes that with his or her 1040 tax return.
An LLC with more than one owner is treated as a general partnership for its taxes. The LLC does not pay taxes. Each LLC owner reports their share of the profits and losses on their personal income tax returns.
How do LLCs pay taxes?
LLC’s filing as Sole Proprietorships take advantage of “Pass-Through” taxation. This means that the company only pays taxes once rather than paying taxes on the profits and again when paying the owner(s), known as “Double Taxation).
The tax rate for the LLC is the same as the individual’s tax rate, based on total individual income to determine the tax bracket. LLC’s will be responsible for Self-Employment Taxes (detailed in the following section) plus their standard Federal, State, and Local taxes at the standard rates. Based on the Jobs Act, LLCs currently may be eligible for a 20% Pass-through Tax Deduction that benefits Small Business Owners.
For S-Corps vs. LLCs, there is a slight difference. In this scenario, income from the LLC is split into payments made to owners as wages and payments made as distributions. The salaries are for the LLC’s owners who actually work for the business. Salaries are subject to both the Self-Employment Taxes and the standard Federal, State, and Local Taxes. The wages must be “reasonable.” This essentially means that the salaries are comparable to the industry standard for the work being done. LLC owners often try to make the salary lower to pay taxes on a lesser amount.
Distributions are made from whatever profit is left over after covering all salaries and expenses. The distribution still requires normal Federal, State, and Local taxes, but not the self-employment taxes, which at 15.3% can add up.
C-Corporations are subject to Double Taxation as described above. The company profits are taxed, and the individual owners have tax consequences as well. While the overall tax burden is larger, it is possible that the owners’ tax rates could be lowered by setting it up this way.
If you want to know more about different scenarios to decide between Sole Proprietorship, S-Corp, and C-Corp we’d suggest talking to your legal and accounting professionals. Understanding the basic differences between LLCs vs. corporations and what you need to know about each can help you determine the best course of action for your business.
LLC Self Employment Taxes
As individual employees working for a company, we are all used to seeing FICA, Social Security Tax, and Medicare Tax as a deduction on our paychecks. As an employee, in most situations, this equates to about 7.65% of our gross wages (minus pre-tax deductions). Many individuals do not realize that the company cutting our paychecks also matches this same amount of 7.65% paid to Social Security and Medicare. For LLC’s including Sole Proprietorships, the individual is responsible for the entire 15.3% (7.65% x 2). Keep in mind this is in addition to the Federal, State, and Local taxes paid based on the individual’s tax bracket.
Looking at the S-Corporation scenario above, LLC members would be responsible for the 15.3% Self-Employment tax on the reasonable wage that they pay themselves. They would not be responsible for the 15.3% tax on the distribution, just Federal/State/Local taxes.
LLC Income Taxes
Single Owner LLC Income Tax
As stated above, single owners can choose to pay taxes as Sole Proprietorship, where the IRS views them as a “disregarded entity.” In this scenario, the owner is responsible for Federal, State, Local, and Self-Employment taxes. Filing as an S-Corp gives them the option of leaving some of the profits as Distributions, which avoids the Self-Employment taxes.
Multi-Owner LLC Income Tax
Multiple members of an LLC are viewed as “Partnerships” by the IRS. These entities must pay Self-Employment taxes regardless if they take distributions.
LLC Payroll Taxes
If a Limited Liability Corporation has employees, it will need to pay payroll taxes. Keep in mind that this does not apply to single-member LLCs or multi-member LLCs without any non-ownership employees.
For employees, the LLC is responsible for paying half of the 15.3% FICA/Medicare/Social Security. The employee pays the other half out of their paycheck.
State Taxes & Fees
State Taxes and Fees, as well as local taxes (such as City Taxes), are paid regardless of single or multi-member. They are also due regardless of Sole Proprietorship, S-Corp, or C-Corp status. While there may be certain LLC-friendly deductions on a state-by-state basis, in general, LLC owner members would expect to pay State Taxes at their normal qualifying rate.
LLC Tax Forms and Deadlines
Sole proprietorships are due on regular tax day – April 15th. For Partnerships and S-Corporations, the due date is one month earlier, on March 15th.
There are a few different forms that an LLC may use to file taxes. For single-member LLCsfiling as a Sole Proprietorship, a 1040 form will suffice. For single-member LLCs filing as a Corporation (such as an S-Corp), they will use Form 1120S or 1120. Lastly, for multi-member LLCs filing as a Partnership, they will use Form 1065. Multi-member LLC’s filing as a corporation would use Form 8832.
Frequently Asked Questions
Is an LLC better for Taxes?
A Limited Liability Corporation is a legal entity formed to protect the owner’s assets in a legal matter pertaining to the business. However, there are certain situations, such as the Jobs Act, that provide tax deductions for LLCs.
How much does an LLC get taxed?
LLC’s are taxed based on the owner’s tax bracket and the method of filing (Sole Proprietorship, S-Corp, Partnership, or C-Corp, for example). Sole Proprietorships are taxed at the standard Federal/State/Local rate plus total Self-Employment Taxes minus any deductions from the Jobs Act. S-Corps are taxed at Federal/State/Local rate plus total Self-Employment Taxes for reasonable wages paid to the owner, and Federal/State/Local without Self-Employment Taxes for distributions. Partnerships are taxed at Federal/State/Local rate plus total Self-Employment Taxes at the appropriate rates for each member of the multi-member LLC. C-Corps are taxed initially on profits and then again when paying out to ownership members at Federal/State/Local rate plus total Self-Employment Taxes.
Does an LLC save money on taxes?
There is a tax deduction through the Jobs Act. Additionally, many business expenses can be deducted from taxable income. Finally, filing as an S-Corp could potentially reduce some Self-Employment Taxes by earning through a distribution rather than a paycheck.
How often does an LLC pay taxes?
LLCs file taxes annually. LLCs can file estimated taxes quarterly based on previous year earnings or actual quarterly earnings. Then, when it comes time to do taxes at the end of the year, the total quarterly payments will be deducted from the total tax expense. If the quarterly payments were greater than the total for the year, the LLC will be refunded the difference.