The establishment of a corporation or a limited liability company takes your business to yet another level in all senses. Legally separating your venture and making it a legitimate entity with its own rights and liabilities, business incorporation also entails more complex regulations and rules to follow, especially when it comes to taxation. For many entrepreneurs, taxation is a flimsy ground they don’t feel confident with. So, knowing and understanding your options is always a nice thing to be able to manage your tax burden and discover smarter financial solutions. Plan an LLC incorporation and want to find out how your future income will be taxed? Keep on reading to learn more about LLC taxation methods, income-related taxes to be paid, deductibles, and how LLC formation services can help you handle your business taxes(learn more in the guide by lawyer D.Kondratiev).
LLC Formation Tax Options
One of the biggest selling points of an LLC as a business structure is flexible taxation. Unlike other entities, LLC companies give you the benefit of choosing tax classification for your newly formed entity. By and large, the LLC taxation method and the way your company will file taxes depend on the number of owners. Basically, there are three tax classifications for single- and multi-owner LLCs:
- Disregarded Entity: Sole proprietorship taxation is a default method for single-member LLCs that are treated by the IRS as disregarded entities subject to pass-through taxation. It means there are no business taxes to be filed and all company revenues and expenses pass on to the personal tax returns of its owner. i.e. your personal ones. Single-owner LLCs file Form 1040, schedule c to report their incomes. In this case, the LLC company’s income is taxed at your individual rate after deduction of expenses. If your business has losses after company creation or due to some other reasons, those losses can be extracted from your personal income before taxation. Yet, note that, even if you decide to keep the LLC profit on the business account to use it for business promotion and development, it is still taxable.
- Partnership: LLC companies incorporated by two or more members function as partnerships in the eyes of the IRS. They are still pass-through entities free from federal tax filings. with their incomes and expenses being transferred to the personal tax returns of their members pro-rata to their ownership shares. Company’s expenses, losses, and credits are split in a similar manner and income taxes are payable at individual rates of the business owners. To report their taxable income, though, multi-owner LLCs should submit informational Form 1065 to the IRS to show their partnership profit and issue Schedule K-1 for each member specifying the respective part of the income, deductions, and losses.
- Corporation: An exclusive benefit of LLC formation is an option to classify your business as a corporation for tax purposes. Without changing the legal business structure, your company can be taxed as a C-Corp or S-Corp. This decision should be taken by the majority voting and reflected in the Operating Agreement since you won’t be able to get back to LLC taxation within the next 5 years and even then, switching back could have unexpected tax consequences for your business. Electing a C-Corp status, you’ll stick to corporate taxation paying an LLC income tax at a 21% corporate rate instead of individual rates and filing Form 1120 for your business tax return. Notably, any revenues left in the company by the owners are not taxable at a personal level. Opting for an S-Corp status, you’ll still follow the pass-through scheme for company revenues, with the main difference lying in self-employment taxes and dividends taxation. LLCs taxed as S-Corps file Form 112-S to the IRS annually.
LLC Self-Employment Tax
Generally, LLC members are not considered company employees even if they are engaged in business activities. Yet, they are still exposed to self-employment tax to cover social security and medicare taxes. In the meantime, a 15.3% self-employment rate is not withheld from their income and needs to be paid to the IRS separately by each company owner, which means LLC members pay both personal income and self-employment taxes. An S-Corp status, on the other hand, helps avoid such a taxation burden by treating owners active in business as company employees and their profits as wages. The rest of the company profit can be allocated to owners as non-dividend distributions not subject to self-employment tax. This is a good way to optimize tax payments for LLC company members with higher levels of profit and avoid paying higher rates.
LLC Formation Tax Rates
Normally, business taxes are filed at federal, state, and local levels. Yet, upon LLC incorporation, your venture will be considered a pass-through entity not liable for filing federal and state tax returns. Hence, formally, there is no such thing as limited liability company tax rates. However, LLC incomes are taxable at a personal level and taxed under individual rates of the LLC company owners. Those rates vary depending on the total profit amount and range from 10% to 37%. In other words, the higher your profit, the higher the tax rate. Companies taxed as C-Corps, on the other hand, pay income taxes at a 21% flat rate, with no self-employment tax on LLC profits and fixed 15% and 20% rates on dividend distributions exceeding $38600. Thus, this form of taxation is more beneficial for companies and individuals with high profits.
LLC state taxes are treated in the same manner as federal ones, with the rates varying by the state. Yet, some states also levy some specific taxes depending on the amount of your company profit as well as annual fees that differ by state a might range from moderate $100 to hefty $800. To learn what added state charges are waiting for your LLC formation ahead, check with your Secretary of State’s Office. Besides, there are some local taxes that might be applicable to the area where your company operates. For those, you can contact your local revenue Department.
Can LLC Services Help With My LLC Taxes?
The modern legal market is not deprived of helpful tools to smartly manage and run your business. LLC formation services are among the most popular online tools that can come in handy not only for business formation but also for its further maintenance. By comparing business formation websites, you’ll see that the best LLC services are those that function as one-stop-shops for different business needs, covering many add-ons beyond LLC incorporations. Most often than not, those add-ons include tax consultations to better understand your options and create a plan for your individual business situation as well as filing tax reports so that you rest assured your business taxes are filed in a due manner and in time.
Dmitriy Kondratiev, chief Editor of LLC.services, associate in Axon Partners.
Experienced lawyer (Intellectual Property, Patenting, Contract law, Labor Law, International Private Law).
Worked with IT-companies Webxloo (Delaware), Autoxloo (Florida), SCC (Delaware)