In the United States, there are a few different types of business entities. For example, there are S-corps, regular C corporations, sole proprietorships, partnerships, and limited liability companies, known as LLCs. LLCs are formed within an individual state. They are typically formed in order to provide limited liability protection for the owners (known as members.
Members are able to choose how they wish to be taxed, and then are done so at their personal tax rates. As there are different forms of LLCs, such as single-member LLCs, multi-member LLCs, and LLCs that elect taxation as corporations, there is a lot to learn regarding LLCs and how they are taxed.
How are Limited Liability Companies
Taxed in Texas?
Although Limited Liability Companies (LLCs) are separate entities, they are not taxed as such. Instead, they are taxed as what the IRS calls a “pass-through entity,” like a partnership or sole proprietorship.
The income taxes you’re required to pay as a business varies depending on the type LLC you formed: single-member or multi-member.
When looking into how a single-owner LLC is taxed, it is quite similar to that of a sole proprietorship. When you file taxes as a single-member LLC, it is the exact same as doing your own taxes. You file based on all the profits or losses that happened within the LLC that year. Then you can choose to write off any business expenses, and pay taxes. Despite this, the LLC itself does not pay taxes. Although some states do not necessarily recognize single-member LLCs, Texas does. It is actually one of the most common entities in the state of Texas.
There is not much of a difference between how a single-member LLC or multi-owner LLC pays its taxes. Members are still required to pay taxes through their personal tax returns, but the IRS treats multiple partner LLCs as partnerships rather than sole-proprietorships.
One of the best benefits of an LLC is that the entity can elect taxation. LLCs are automatically taxed as sole proprietors if there is one member and as a partnership with two or more members. Despite this, an LLC is also able to elect corporate taxation which has some options on its own.
Some LLCs choose to be taxed as a C-corp. This is known as the “standard” corporation. Another option is to elect status as an S corporation. Typically businesses will elect corporate taxation when high-income owners are involved. The federal corporate taxation level is 21%. For anyone making over $54,201, the percentage is 22%, while anyone making over $164,901 will be paying 32% in taxable income. There are also Texas state corporate taxes which are around 1%.
Choosing to elect taxation as a corporation doesn’t change the way you operate as an LLC. instead, it only changes how much you will need to pay, and how you do so. Regardless, an LLC is always required to operate according to their operating agreement, or state law if no operating agreement is present.
What is Tax-Deductible for a Texas LLC?
One of the many benefits of creating an LLC in Texas are the tax write-offs. LLC owners can deduct most of their expenses from their taxes to reduce the amount they need to pay, whether they pay quarterly or annually.
Here are a few of the most common tax deductions for Texas LLC owners:
- Car expenses: Cars used for business purposes, including gas and service.
- Advertisements, Utilities, Repairs, Office Supplies: During the first year in business, you may deduct up to $5000 for start-up costs. Other amounts over this must be written off in intervals for 15 years after.
- Legal, professional, and accounting fees: You may want to hire professionals to help your business run smoothly. This might include using software like Turbotax or hiring an accountant.
- Insurance: If you do not have insurance then you may want to think about this further because business insurance is tax-deductible. You can deduct many forms of insurance such as employee medical benefits insurance, fire, theft or flood insurance, credit insurance, liability insurance, and unemployment insurance contributions.
- Travel: Business travel expenses such as lodging, plane flights, Uber, meals, shipping, and tipping is all considered tax-deductible as long as it is contributing to your business.
- Interest: It is common to use credit or loans when starting a business. Any interest charged is considered tax deductible, and you can take out a personal loan for your business as well. If the business profits become more than $25 million then you can only legally deduct 30% of the total interest.
- Equipment: Should you use the equipment for your business like computer software, materials, and machines, then you can depreciate them and write them off on your taxes.
- Charity: Donations from your LLC are considered a tax-deductible expense.
Taxes That Texas LLC Owners are Required to Pay
As an LLC owner, you want to keep your business in good standing with the state. To do that, you need to know which taxes you are required to pay and when to pay them.
These are the taxes Texas LLC owners need to be aware of:
Self Employment Taxes
As a self-employed individual, you need to withhold your own taxes because you are essentially your own employer. The total amount of employment taxes in the state of Texas are 15.3%. 12.4% of it is dedicated to Social Security and 2.9% is dedicated to Medicare.
If you have employees at your LLC then you will be required to pay employer taxes both federally and to the state. You will need to register to pay state unemployment insurance taxes as well.
Sales and Use Taxes
If you plan to sell goods through your LLC in the state of Texas, then you will be required to collect and pay sales tax. Generally, the Texas state sales and use tax rate is 6.25%. Despite this, local taxing jurisdictions (cities, counties, special-purpose districts, and transit authorities) are also allowed to add up to 2% for a combined total of 8.25%.
In Texas, there is a Franchise tax. This essentially means that an LLC will need to pay a percentage on its "net surplus" (all net assets of the LLC minus contributions by members). The “No Tax Due Threshold” is $1,180,000. The tax rate for either retail or wholesale is 0.375%, while anything other than retail or wholesale is taxed at a rate of 0.75%.
How LLCs Pay State income tax
Forming an LLC is a great way to separate your business assets from your personal assets. It is important that you know how to file and pay state income tax as an LLC, in order to stay compliant with the law. LLCs report all income and expenses through a Form 1040 Schedule C.
This is similar to how a sole proprietor files taxes because LLCs are taxed in the same method. After deducting expenses and recording profit, taxes can be paid to the IRS, but through your own personal tax rate. For those LLCs electing corporate taxation, you will follow the route of corporations instead.