Understanding how Llc Members Pay Taxes

Understanding how llc members pay taxes

Limited liability companies (LLCs) are one of the most popular types of business entities. The LLC’s flexible taxation options are one reason it is preferred; LLC members can, for the most part, choose how they would like to be taxed. The LLC enjoys this flexibility because the Internal Revenue Service (IRS) does not recognize it as a distinct entity for federal tax purposes.

It must, therefore, be taxed as one of the four taxable options already available:

DISREGARDED ENTITY

A disregarded entity is a business structure that is not recognized as distinct from its owner for tax purposes. If you are the sole owner of a single-member LLC, the IRS classifies your company as a disregarded entity by default and taxes the LLC as a sole proprietorship. As a result, the owner of a single-member LLC must report the LLC’s income and expenses on the member’s Form 1040 Schedule C. A separate tax return for the entity is not required.

PARTNERSHIP

When an LLC has multiple members, the IRS’s default classification for tax purposes is the partnership. Partnerships, like disregarded entities, pass their income and expenses down to their owners, and LLC members are responsible for paying taxes proportionate to their ownership interests. Income, credits, and deductions are reported to the IRS using Schedule K-1 (Form 1065).

CORPORATION

If an LLC does not want to be taxed as either a sole proprietorship or a partnership, it can elect to be taxed as a corporation by timely filing Form 8832. Electing taxation as a corporation may be beneficial in several ways. If the company does not intend to pay out dividends, electing to file taxes as a corporation allows LLC members to avoid reporting the business’s income on their personal income tax returns.

Because personal income tax rates are often higher than corporate income tax rates, this may allow individuals to benefit from the lower corporate income tax rate. Additionally, LLC members may avoid paying self-employment taxes. Thus, corporate taxation may have money-saving benefits for LLC members.

S CORPORATION

The S corporation tax election is unique. Unlike the other three options described above, the S corporation is not a different entity type.

Rather, it is a corporation that meets all of the following criteria:

  • It has less than 100 owners
  • All of its owners are United States citizens or residents
  • It has only one class of membership
  • Its membership is not comprised of any partnerships, corporations, or non-resident aliens

If an LLC chooses to be taxed as an S corporation, the LLC members enjoy pass-through taxation unlike a standard corporation. Moreover, the income that is taxed as a distribution is not subject to self-employment tax. Finally, an S corporation allows its owners to take advantage of the Qualified Business Income Deduction of up to 20 percent. There are some limitations as to which industries qualify for this unique deduction. You must timely file IRS Form 2553 to elect S corporation taxation.

THE BROWNE FIRM CAN HELP

Choosing the right structure for your business can be challenging, but we are here to help. Call The Browne Firm to schedule a meeting with one of our experienced attorneys. We can help you form your LLC and choose the best tax structure for your company.

For more information about what The Browne Firm can do for you, contact us online or call 914-331-7881 for assistance!

Author Bio

Danielle Browne is the founder and managing attorney of The Browne Firm, a New York-based estate planning and business law firm. Danielle leverages her background, serving as general counsel for a Fortune 500 company and working with startups to represent clients in entity formation, intellectual property protection, contract drafting, estate planning, and more.

With more than ten years of experience as an attorney and business executive, she has represented clients ranging from entrepreneurs and small businesses to artists and Fortune 500 companies. Danielle received her Juris Doctor cum laude from the University of Miami School of Law and is licensed to practice in New York. She has received numerous honors for her work, including being named a 2015 Future Leader by the WNBA President while serving as general counsel for the Atlanta Dream.

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