Setting up or transitioning your small business as a Limited Liability Company (LLC) is a great way to protect your personal assets from business-related debts and lawsuits. But how will it affect your income tax?
The IRS doesn’t recognize LLC as a business classification — unlike sole proprietorships, partnerships, and corporations. That means you can choose to identify yourself as one of those classifications when you file your income tax.
Note: If you don’t declare your choice, the IRS will default you to either a sole proprietor (one owner) or a partnership (more than one owner).
Here’s how to do it.
This is considered a “pass-through” business. Any business income or losses are passed through to your personal ownership and are reported on your personal tax return. You have to do it this way whether the profits from the business go into your personal bank account or stay in the company’s account for paying business expenses.
Since the LLC registration is done at the state level, the business itself doesn’t pay any federal income tax. However, some states require an annual franchise tax for LLCs.
- Report LLC income on Schedule C of your individual tax return (usually Form 1040).
Use this election if your LLC has multiple owners but you don’t want to pay taxes as a corporation.
As with a sole proprietorship, the IRS considers the multi-member LLC a pass-through entity — business profits and losses are reported on each member’s personal tax return.
The profits or losses are divided up among the members according to the percentages stated in your operating agreement. For example, if you have one co-owner, each of you could be responsible for 50% of the profits or losses.
- The partnership must file Form 1065, which is an informational statement of the LLC’s income, gains, losses, deductions, credits, etc.
- In addition, the LLC must provide each partner with a Schedule K-1 which reports that member’s share of the profit or loss and will be filed with their personal tax return.
LLCs may choose to be taxed as a corporation that is responsible for filing its own business tax return. With this choice, you will avoid being personally liable for fines and penalties if you are late filing the company’s tax return.
Filing as a corporation is also smart if you plan to keep most of the profits in the business instead of transferring them to your personal use.
You (and your partners, if any) can elect to be taxed as a C-corporation or an S-corporation. A C-corporation is a stand-alone entity that pays corporate taxes, meaning that you could be taxed on both the corporate and personal levels. An S-corporation is a pass-through entity and does not pay corporate income tax. All revenues are either distributed as wages or passed through to the owner(s) as dividends.
The tax advantage of an S-corporation over a sole proprietorship or partnership is that you are considered an employee of the company. Therefore, you will only pay FICA (Social Security and Medicare) tax on the wage the company pays you. Any other profits you take out of the business are taxed as dividends, not subject to FICA tax.
- To inform the IRS that you are electing for your LLC to be treated as a corporation for tax purposes, file Form 8832.
- To be treated as an S-corporation, first, establish your eligibility by filing Form 8832, then file Form 2553.
- File your tax return on Form 1120 (for C-corporations) or Form 1120-S (for S-corporations).
Meeting the requirements to file as a C-corporation can be tricky — and even more so as an S-corporation. We recommend that you consult your accountant to make sure there are no mistakes that could cause you to lose your money-saving tax status.
Your Xendoo team of accounting experts can help you find the right solutions for your small business, and take the hassles of tax prep and filing off your shoulders. We’ll do what we do best — and let you get back to doing what you do best to make your business a success.