How Is an LLC Taxed?

StrategyDriven Managing Your Finances Article |LLC|How Is an LLC Taxed?Easily one of the most daunting parts of being an entrepreneur, tax season can be complicated if you’ve never been exposed to doing business taxes before.

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!

StrategyDriven Editorial Perspective – No Free Lunch

There exists a pervasive and ongoing belief among many that government has the power to eliminate hardship and create prosperity for everyone. Nothing, of course, could be farther from the truth.

“You don’t make the poor richer by making the rich poorer.”

Winston Churchill
Prime Minister of the United Kingdom
(1940-45, 51-55)
and Nobel Laureate (literature)

The following video is that of a lecture made by Nobel Laureate and Economist Milton Friedman. In his discussion, Dr. Friedman illustrates why there is no free lunch, why no combination of government programs can simultaneously create wealth and prosperity for all individuals. Thus, when government spends money, it is always at someone’s expense. He goes on the dispel the myth that corporations pay taxes of any sort and how continuing such policies further injures the economy and employees.

Dr. Friedman’s assertions are not political but are instead based on sound economic theory and real-world experiences. These principles equally apply to organizations to the extent that compensation, benefits, privilege, and authority are proffered in a manner inconsistent with the value contribution of the individual.

StrategyDriven Recommended Practices

Highly accountable organizations benefit from the premise that there is no free lunch. Executives, managers, supervisors, and individual contributors are held accountable for their actions and contributes both positively and negatively. StrategyDriven leaders should therefore take the actions necessary to create and promote accountability throughout their organization. At a high level, these actions include:

  1. Clearly defining the organization’s mission in terms of quantifiable goals and values
  2. Broadly communicate the organization’s mission and values
  3. Cascading these mission goals into a performance metric system that establishes the results to be achieved at each level of the organization and ultimately by each employee
  4. Codify the individual level performance metrics and organizational values within position descriptions, observation programs, and individual performance goals
  5. Award organizational positions based on individual knowledge, skills, experience, contributions, and adherence to the organization’s values
  6. Establish a compensation and benefits program that equitably distributes rewards based on an individual’s value contribution and adherence to the organization’s values
  7. Provide continuous, ongoing feedback and coaching to both reinforce the achievement of the organization’s goals in a manner consistent with its values and to further develop personnel and improve performance

“Organizational accountability exists when all members of the workforce individually and collectively act to consequentially promote the timely accomplishment of the organization’s mission.”

StrategyDriven Contributors

Additional Information

StrategyDriven believes the practice of ‘no free lunch’ reflects an organizational commitment to praise-worthy values. Leaders seeking to infuse their organization with such beliefs are supported by the tools presented in our principle, best practice, and warning flag articles within the following topics: