LLC Income Tax Options for LLC Owners

A Limited Liability Company (LLC) is a relatively new form of business entity, having been recognized by the IRS only since 1980. The LLC combines the ease of startup and operation of a sole proprietorship or partnership with the liability protection of a corporation. Because the IRS doesn't have a tax classification for LLC's, it chose to use existing tax classifications for other business types for LLC taxes.

LLC Ownership and Taxes

An LLC pays income tax differently depending on the type of LLC and the ownership structure. LLC owners are called members, and an LLC can have one member (called a single-member LLC) or many members. In addition to having an individual person as a member, an LLC can be owned by a corporation, an s corporations, another LLC, a trust, or a pension plan.

LLC's are pass-through entities, meaning that the profits of the LLC are taxed by passing them through to the members to be paid on their individual income tax returns, along with their other income.

LLC owners are not employees, they don't receive wages or salaries, so they must pay self-employment tax (Social Security and Medicare tax) on their share of the LLC's profits. This tax is also paid on the member's individual income tax return.d

If the owner is an entity like a corporation or another LLC, the income tax for that member's share of taxes is paid on the tax return of the owner (a corporate income tax return, for example).

How a Single-owner LLC Pays Taxes

An LLC with a single member/owner is taxed in the same way as a single owner business - a sole proprietor. Like the sole proprietor business, the single-member LLC files its tax return on Schedule C. The profit or loss from the Schedule C is included with the owner's personal tax return.

How a Multiple-owner LLC Pays Taxes

An LLC with more than one member (owner) pays taxes as a partnership. to file partnership taxes, the partnership files an information return on Form 1065 showing the total profit/loss from the partnership. Each partner receives a tax form (Schedule K-1) showing his or her portion of the partnership profit or loss. This Schedule K-1 income/loss is included with the owner's personal tax return.

Income Taxes for LLC's Taxed as Corporations or S Corporations

Now comes the complication: An LLC has two other options for paying income taxes - either as a corporation or an S corporation.

LLC paying taxes as a corporation. An LLC can pay taxes as a corporation. The business must file IRS Form 8832. Read more about filing an entity classification election on Form 8832. Then the LLC files a corporate income tax return to calculate the profits and the taxes that must be paid. d

LLC paying taxes as an S corporation. An LLC can pay taxes as an S corporation. The benefit of filing as an S corporation rather than a corporation is that the S corporation owners can report their business income/losses on their personal tax returns and they do not incur double taxation. The S corporation files a tax return on Form 1120-S and the S corporation owners file a Schedule K-1, which is similar to the Schedule K-1 filed by LLC members.

Understanding the Difference Between an S Corp and an LLC

Before you consider changing your LLC's tax status to that of an S corporation, read about the tax differences between an S corporation and an LLC.

To change tax status to that of an S corporation, the LLC must meet the IRS requirements for S corporations, including (a) it must be a "domestic entity eligible to be treated as a corporation" (that is, an LLC), (b) it can have no more than 100 shareholders (members, in the case of an LLC), and (c) its only shareholders are individuals, estates, exempt organizations, or trusts. The entity must also have a December 31 fiscal year-end.

Any filing to change LLC tax status to that of a corporation or S corporation should be done with the assistance and advice of a tax professional.