In this article, we’ll explore how LLC taxation works, so as an LLC owner, you neither overpay nor underpay the government.
Before We Discuss LLC Taxation
Before we get into the nitty-gritty details of LLC taxation, it’s important to first understand what an LLC is.
A Limited Liability Company is one of the simplest ways for a new employee to structure their business and have it recognized as a commercial entity in the government’s eyes. The requirements to form an LLC are low, making it the path of least resistance for budding entrepreneurship to achieve legal status.
Forming LLC (through an attorney or online service) enables owners to protect themselves with limitations of the risk their personal assets face, should something untoward happen with the company. In addition, starting fees are relatively small (less than $200 in most states).
The principal benefit of LLCs, however, lies in the discussion of LLC taxes. LLC’s are single taxation entities, meaning that unlike corporations, the income can only be taxed at one level (business or personal income).
How is an LLC Taxed?
The answer to this question technically depends on how the company is structured. If the company is structured as a collection of multiple partners, then the LLC’s income is taxed only at the personal income level.
That means that each of the shareholders in the LLC report income from the LLC as their personal income, and they file individual tax returns. No additional forms have to be completed for the LLC itself.
However, if the LLC is structured as a C corp or S corp, which it can elect to do after it’s created, then it will be required to submit additional documentation. The IRS Form 8832 is used for the LLC to elect to submit taxes as either a C corp or an S corp. The documentation submitted thereafter will determine what additional forms the LLC uses to be taxed (Form 2553 for an S corp and Form 1120 for a C corp).
Without corporation status, the LLC’s income is classified as “pass-through” which means that it just goes into each owner’s personal income return.
Do LLC’s Pay State Income Tax?
Some states require that LLC’s pay income tax at the state level. This is fairly common, and will often take the form of a franchise fee.
The franchise fee is an annual fee submitted whenever the LLC submits its annual report. The annual report contains information regarding total revenues, total operational expenditures, philanthropic expenditures, etc..
Most states will use the federal tax liability as a starting point for their own tax determination. Look up your individual state’s LLC tax law to figure out how much you’ll be liable for this April.
Don’t Mess Up Your Taxes!
Few things can kill a growing company’s momentum than falling on the wrong side of the IRS. Take the right steps to ensure that you’re completing your LLC taxation correctly — look up state laws, fill out the right forms, and consider calling a professional if you need help.
Once you’ve gotten through this tax season, make sure to come back and subscribe for more small business advice!