Income Tax Basics for Your LLC
The thought of income taxes may bring on an immediate headache as you envision hours of wading through stacks of papers and electronic records. But having a solid understanding of how your Limited Liability Corporation is taxed will help you get organized and have all your ducks in a row when tax time rolls around.
Organizational Structure vs Tax Entity
Structuring your business as an LLC does not automatically determine how it will be taxed: That is largely up to you and your business partners. A Limited Liability Corporation, as its name implies, protects the individual business owners from personal legal responsibility for debts accrued by the business. It does not, however, dictate how the business taxes will be paid.
Paying Taxes as a Single Owner LLC
If you are the only owner of your LLC, you basically have two options for paying your taxes:
- You can opt to be taxed as a Sole Proprietor. Now, before you panic, realize that this is for tax purposes only. You will still retain the legal protections of an LLC. You will simply file a Schedule C form along with your personal federal income tax form. Unless you opt otherwise, you will automatically fall into this category.
- You can elect to be taxed as a Corporation, rather than as a Sole Proprietor. Depending on the size and income of your business, this may be a favorable option in terms of paying lower taxes. It is something you should discuss with your attorney or CPA. In order to be taxed as a Corporation, you must file form 8832, “Entity Classification Election,” with the IRS.
Paying Taxes as an LLC Partnership
If you share ownership of your business with one or more other members, your LLC will be taxed as a partnership. As such, the individual partners will each be responsible to pay taxes on their share of the profits. As with the single owner LLC, all partners still retain liability protections from the company’s debts. Here is how it works:
- The LLC files form 1065 with the IRS.
- Schedule K-1, showing each member’s percentage of profits and losses, is prepared and distributed to each member of the LLC.
- Each individual member submits Schedule K-1 along with their personal income taxes.
- As with a single owner LLC, a multiple-member LLC may opt to be taxed as a Corporation. This option is usually taken when the LLC’s income is extremely high, in order to get a lower tax rate. Again, this is something you should discuss carefully with your CPA.
As you can see, paying taxes as an LLC is pretty straightforward. You can make the process worry-free by keeping organized records of your LLC’s income and expenditures, and by clearly delineating each partner’s share in the LLC.