A Limited Liability Company (LLC) is a pass-through entity and is taxed by the IRS like a sole proprietorship or partnership, meaning that the profit or loss of the LLC flows through to the members/owners of the LLC, where it must be reported on their individual personal tax returns. The LLC, itself, is not required to pay federal income. However, depending on the state, it may be required to pay certain state taxes.
The default federal tax status for an LLC is a sole proprietorship or partnership, depending on whether it is a single-member LLC or multi-member LLC.
A single-member LLC is taxed like a sole proprietorship by the IRS, which means that its profit or loss is reported on the single owner's personal tax return.
Multi-member LLCs are taxed by the IRS as partnerships. In this case, the income of the LLC will pass through to the members/owners of the LLC, where they will report their respective shares of the LLC's profit or loss (referred to as their distributive share) on their personal tax returns.
Although a multi-member LLC doesn't have to pay income taxes, it must file an informational return (IRS Form 1065), much like a partnership. An LLC must also send each member a "Schedule K-1," which details that member's share of the LLC's profit or loss. The member must then report these details on IRS Form 1040 via Schedule E.
As a way to save money on taxes, the members of an LLC can elect to be taxed like a corporation, if for example, the LLC needs or wants to retain a considerable amount of its profits in the company on a regular basis.
The members of an LLC are not considered to be its employees. Instead, they are considered self-employed individuals, therefore, the LLC does not withhold their taxes. Consequently, each member of the LLC must estimate how much their tax burden will be for the year and submit payments to the IRS (and the necessary state taxing authority) quarterly from April.
Because the members of an LLC are considered self-employed and not employees, the LLC is also not required to withhold their Social Security and Medicare contributions, (collectively referred to as “self-employment” tax) from their paychecks. Rather, in most cases, the members must pay their own self-employment tax directly to the IRS.
Those members who are active in the management and operation of the LLC must pay employment tax on their share of the LLC's profit or loss. However, members who are not actively involved in the LLC are sometimes exempt from paying self-employment tax.
The rules regarding self-employment tax for the members of an LLC can be complicated. Consult with a qualified business tax professional for more precise details.
Self-employment tax is reported annually on Schedule SE along with the member's 1040 tax return. Typically, the members of an LLC pay twice the self-employment tax that ordinary employees pay. This is because the employer pays half of the required employment tax contributions for its ordinary employees.
Money spent by the LLC to generate revenue and increase profits is exempt from income and self-employment taxes. The IRS allows you to “write off” legitimate business expenses from your LLC's income, which you can use to greatly minimize the profits you need to report to the IRS. These items include, among other things:
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