Limited liability companies are a form of business entity. When forming an LLC, you will be provided limited liability protection for all the owners of your business. Owners are called members of an LLC and will be taxed at their personal tax rates.
One advantage to forming an LLC is in regard to income taxes. LLCs are able to elect taxation based on their personal preference, and the number of members that form the organization. What is important to note is that the IRS does not recognize LLCs for tax purposes. This is because an LLC is not a separate tax entity, instead, it benefits from “pass-through taxation”.
How are Limited Liability Companies Taxed in Delaware?
Pass-through taxation is the act of being taxed as either a partnership or sole proprietorship. Limited Liability Companies are not a separate tax entity like a corporation. This means that all profits will flow through the LLC and pass onto the members, who will then be taxed according to their individual tax rate.
Single Owner LLCs
The IRS treats one-member LLCs in the same way as sole proprietorships. This means that for tax purposes, a single-member LLC will not pay taxes. Instead of filing a return with the IRS, the member/owner of the LLC pays taxes through their personal tax return.
Multi Owner LLCs
Co-owned LLCs are taxed as partnerships by the IRS. Similar to a single-member LLC, multi owner LLCs do not pay taxes on business income. Co-owners of an LLC will each be required to pay taxes on their share of the profits, within their personal income tax returns. This is done with a Schedule E attached.
Steps to report income from as a multi-owner LLC is as follows:
- The partnership files an information return with the IRS using Form 1065.
- You receive a Schedule K-1 for each partner. This shows your share of the profit or loss in the partnership.
- Transfer Schedule K-1 information to Schedule E. The Schedule K-1 form will break down your income into different types. Each type of income goes in a specific place on Schedule E.
- Include the income from your Schedule E in the right place on your Form 1040 or 1040-SR.
LLCs are able to elect taxation in a few different forms. Aside from being taxed as a sole proprietor or partnership, LLCs can also choose to be taxed as a C corporation or S corporation.
Typically businesses will elect to be taxed as a corporation in order to reduce tax liability. This is often a choice made by high-income individuals. It is good to note that this election will not change how your LLC operates, but only the way you will pay taxes.
Other LLC Taxes
Every state has its own state taxes. In the state of Delaware, personal income taxes are at a graduated rate. For any income under $60,000, the graduated tax rate is between 2.2% to 5.55%, The maximum income tax rate is 6.60% on income of $60,000 or over.
Delaware also charges a franchise tax, also known as an "annual registration fee" or a "renewal fee." This cost is $300 payable annually.
Self Employment Taxes
Because LLC owners commonly get income from business operations, this is considered self-employment income. This requires you to pay a federal self-employment tax (Social Security and Medicare).
When attempting to pay self-employment taxes, you must complete a Schedule SE form to calculate how much you owe. This is based on your business net income and added to your other income on your personal tax return.
How LLCs Pay State Income Tax in Delaware
Overall, LLCs can elect how they want to be taxed. Whether this is as a corporation, sole proprietor, or partnership, LLCs can choose this election. State income taxes work in the same way. In Delaware, LLC members pay taxes to the state on their personal returns. The LLC itself does not pay a state tax.
Before forming an LLC, you should always look into the logistics, and see if it is the right decision for you. Contact a lawyer for more information to make this important decision.