If you're considering establishing an LLC for your business, keep these tax considerations in mind.
- How your LLC is taxed depends on how many members it has on its roster.
- Getting taxed like a corporation is possible under an LLC, which may result in lower tax rates overall.
- Like other business types, LLCs offer some deductions that can further reduce your tax burden.
- This story is for a small business owner operating under an LLC who needs additional information about how to file their business taxes.
As the owner of a small business, ensuring your taxes are handled properly and on time is important. If you've incorporated your venture as an LLC, or limited liability company, then you have specific tax considerations to keep in mind when you have a looming tax filing deadline.
With the right forms in hand and a general knowledgebase, you can ensure that the IRS won't come knocking on your door at a later date.
How different types of LLCs prepare and file their taxes
When it comes to the LLC classification, there are a handful of configurations that determine how you file your business's taxes. This sort of flexibility within the LLC business structure is great for companies looking to operate in a specific manner, but can sometimes be cause for confusion during tax season.
All members of an LLC are considered self-employed, so they must pay their own self-employment taxes for Social Security and Medicare.
State taxes are also important to keep in mind, though those differ based on each state's tax laws and requirements. When getting your state taxes in order, consult your state government's tax division to find out what forms and information you need in order to file.
Though the entire process can be done by hand, many of today's most popular online tax solutions can speed everything up for you. It's important to note, however, that the free versions of these solutions rarely cover business taxes.
In the eyes of the IRS, a single-member LLC and a sole proprietor are practically one and the same.
As such, taxes for this style of business are prepared and filed in the same manner, meaning they are added to a personal tax return.
The biggest differentiator between a single-member LLC and a sole proprietorship is that LLCs shield you from liability in nearly every case. Where major events such as a bankruptcy or lawsuit against your business have the potential to result in great personal loss, LLCs limit the liability to business assets, saving your personal assets like your home and personal savings.
According to the IRS, the owner of a single-owned LLC must include a Schedule C – Profit or Loss from Business – with their 1040 or 1040-SR. A Schedule C form is used to calculate and report a business's income or losses in the previous tax year.
Through the Schedule C form, your business's profit will be calculated by adding all revenue and subtracting the costs of goods and services. Any other associated business expenses are considered in the calculation as well. Once completed, the final sum is the business's net profit, which is added to Line 12 of the 1040. That income is included in your personal income and taxed accordingly.
If you've decided to start a business with other people and filed to become an LLC, then you're likely in a multimember LLC.
Regardless of how many people are involved in this type of business, the IRS considers them a partnership for tax purposes. Like their single-owner counterparts, multimember LLCs have their profits and losses reflect directly on the ownership, meaning that each owner pays taxes on their cut. That division of profits is determined in the LLC's operating agreement, which generally bases each owner's profit share on the amount of their investment into the business.
When getting taxes tabulated and filed for a multimember LLC, the entity must file a Form 1065 – U.S. Return of Partnership Income – to the IRS. This form provides the IRS with the business's profit and loss statement, a list of deductible expenses, and a balance sheet that shows financial information at both ends of the tax year.
Once filed, the LLC then provides each member with a Schedule K-1 to lay out a partner's share of the company. This form provides the IRS with an in-depth look at each partner's personal profits and losses generated by the company. Each partner must file their Schedule K-1 form with their personal tax return. Also included with a member's personal tax return is a Schedule E, which reports that person's share of profits or losses to the IRS.
Deciding between C-corp or S-corp LLCs
While LLCs have a built-in safety valve against personal liability, they have the option of being taxed as a corporation. Designating a business as an S-corp or C-corp can change how the taxes are handled and how the owners are taxed, among other things. Filing business taxes as a corporation also has the added benefit of potentially reducing your business's tax bill.
- Hold an annual meeting for the shareholders and board of directors
- Issue shares to investors
- Establish a board of directors
- Assign positions like shareholders, directors, officers and employees
Once designated as a C-corp, the LLC files its corporate tax return yearly using Form 1120. Rather than getting taxed individually based on the company's gains and losses, each owner instead is taxed separately from the company. As such, the LLC files its own tax return.
Since the LLC and each of its owners are filing their own taxes, the company's profits experience double taxation. Some people see this as a major disadvantage to filing as a C-corp.
- Be a domestic corporation
- Have only allowable shareholders
- Shareholders may comprise individuals, certain trusts and estates
- They may not be partnerships, corporations or non-resident alien shareholders
- Have no more than 100 shareholders
- Have only one class of stock
- Not be an ineligible corporation (i.e., certain financial institutions, insurance companies and domestic international sales corporations).
According to the IRS, an S corporation can opt to "pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes." Operating largely like a partnership, S-corps file Form 1120-S to report the company's income, losses, deductions and other tax information with to the IRS. The owners then receive a Schedule K-1 to show their share of the business and use that information to complete Schedule E for their own tax return.
Key takeaway: LLCs fall under different specifications, resulting in different tax requirements.
Estimated tax and the self-employment tax
For most LLC owners, their federal taxes will be done as if they were self-employed. As such, each owner will not be subjected to tax withholding, meaning they must estimate their taxes for the year by completing the IRS' 1040-ES form. Corporations can also be required to estimate their taxes and must do so with Form 1120-W. In both cases, you must calculate quarterly tax payments and pay them by the IRS's deadline. If your state also has an income tax, the process is also likely required at that level as well.
According to the IRS, individuals must use the 1040-ES form and make estimated payments if both of the following statements are true:
- You anticipate owing at least $1,000 in taxes after subtracting your withholding and refundable credits.
- You expect your withholding and refundable credits to be less than the smaller of:
- 90% of the taxes to be shown on your upcoming tax return, or
- 100% of the taxes shown on your tax return from the previous year if that return covers all 12 previous months.
To use Form 1120-W, the IRS requires that corporations must meet the following criteria:
- Corporations must generally make estimated tax payments if they expect their estimated tax (income tax less credits) to be $500 or more.
- S corporations must make estimated tax payments for certain taxes. S corporations should see the instructions for Form 1120-S, U.S. Income Tax Return for an S Corporation, to figure their estimated tax payments.
- Tax-exempt corporations, tax-exempt trusts and domestic private foundations must make estimated tax payments for certain taxes.
- These entities should refer to the instructions for their tax return to figure the amount of their estimated tax payments.
In addition to estimated taxes, LLC members must consider the self-employment tax. Based on Social Security tax and Medicare tax, this tax is calculated through Schedule SE and is not unlike payroll tax.
While employee contributions to both systems are taken out of their paychecks, anyone considered a self-employed individual by the IRS does so through their taxes. If you're required to pay your estimated taxes on a quarterly basis, you may also be required to cover your self-employment taxes in that same payment schedule.
The self-employment tax also means your contributions to Medicare and Social Security will be significantly more than those made by employees, since employers match those contributions. According to the IRS, the self-employment tax rate is 15.3%, with 12.4% going to Social Security and 2.9% going to Medicare.
When considering your estimated taxes and your self-employment tax responsibilities, failing to accurately calculate your tax burden can result in penalties. These penalties can sometimes be waived in certain circumstances, but it's best to avoid them in the first place.
Key takeaway: All LLC members must make quarterly tax payments. They must also pay the self-employment tax.
Deductions to keep in mind for your LLC
As you're preparing your taxes, you should always be looking for applicable deductions to ease your tax burden.
According to the IRS, some general credits and deductions available to all types of businesses include items like the Manufacturers' Energy Efficient Appliance Credit and the Plug-in Electric Drive Vehicle Credit, among other things.
That being said, tax deductions specifically tailored to LLCs also exist. For example, if your LLC makes a charitable donation, it can deduct up to 10% of the contribution. [Read related article: Tax Deductions You Should Take – and Some Crazy Ones to Avoid]
In general, how your LLC gets its deductions depends largely on the type of business structure it's taken on. Single-member LLCs can take many of the same deductions that sole proprietors can, like health insurance for yourself, your spouse and any dependents in your home; "ordinary and necessary" business operating expenses like equipment, home office expenses like rent and utilities; and vehicle-based costs mileage and fuel. Conversely, any partnership-based LLC can take deductions based on those found in Form 1065.
Following the passage of the Tax Cuts and Jobs Act of 2017, the federal government also made it so a qualifying small business owner can utilize new pass-through tax deductions of up to 20% of net business income earned. This deduction will run until 2025 and is considered an additional personal deduction if you meet certain criteria. While the TCJA pass-through deductions are available to most small businesses, C-corps are not eligible.
If you have employees and make less than $315,000 (if married and filing jointly) or $157,700 (if single), then you may qualify. Furthermore, this deduction is capped at a percentage of employee wages or the property cost associated with the business. If your business makes more than $415,000 (if married and filing jointly) or $207,500 (if single), then your business is not eligible for the TCJA pass-through tax deduction.
Key takeaway: There are some deductions available that may help you reduce your tax burden.
Whether you're the sole owner of your LLC or work in tandem with other partners, taxes are an important aspect of the operation that cannot be ignored. Figuring out what you owe and making sure your federal, state, and local taxes are paid on time will ensure you can keep running your business unimpeded.