Can LLC Companies Choose Between Tax Structures?
Forming an LLC is one of the most popular business structures for entrepreneurs and business owners. It is so popular because it gives the business owners and members some safety in limiting their personal liability to the company. This means that the company is its own entity and the members will not be held personally liable when there are debts or judgements against the company.
When choosing an LLC as the business legal structure, many entrepreneurs are then surprised to find out that one can actually choose between different tax structures. This is another major decision entrepreneur would need to make, the decision on how the LLC is taxed can affect the business. What is really great about an LLC is that there is a lot of flexibility when it comes to tax structures. Below we discuss all the different LLC taxation structures that business owners can choose from.
Single-Member LLC as Disregarded Entity
A single-member LLC is basically taxed as a sole proprietorship. In this case there is only one business owner or member of the LLC. What’s nice about this structure is that it still provides the business owner with protection, however the taxation benefits are equal to that of a sole proprietorship. In this case ‘pass-through’ taxation is applicable and the business does not file any tax forms. The single owner of the LLC reports the businesses profits or losses on their own personal tax forms. Business owners will have to pay self-employment taxes if they are engaged in active trade or business. If the LLC was formed for passive activity, then self-employment taxes are not payable.
Multi-Member LLC as a Partnership
Federal law dictates that when an LLc has two or more members, the LLC will be taxed as a partnership, unless it elects to be taxed as a C or S corporation. A multi-member LLC, taxed as partnership uses a separate 1065 partnership tax return when members report the business income of the LLC. Each member then pays self-employment taxes on their share of the profits of the LLC. Self-employment taxes are only paid if the members are actively involved in the business or trade.
LLC as C Corporation
Electing an LLC to be taxed as a C-corporation is best if business owners prefer to keep profits within the company rather than distributing profits to owners at the end of the financial year. When electing to be taxed as a C-corp the owners do not pay taxes on the profits of the company and only the LLC will be taxed on profits. One can file the 8832 form with the IRS if it is elected that the LLC be taxed as a C-corp. The LLC has to file corporate tax returns, as well as pay taxes on profits on corporate rates. Only if dividends are distributed to the LLC members will they pay taxes on the dividends, this is also known as double taxation. This structure is not subject to self-employment taxes, however it will be subject to payroll taxes on any wages paid to members of the LLC who work for the company.
LLC as an S Corporation
When an LLC elects to be taxed as an S-corporation the LLC has to file 1120S tax return. In this case the companies profits are not subject to corporate income tax, instead the individual owners of the LLC are taxed on their shares of the businesses profits. These profits are not subject to self-employment taxes. If one of the LLC owners works for the company and earns a salary or gets wges the LLC has to pay payroll taxes on those earnings.
How to Choose the Correct Tax Option for an LLC?
It is really important for business owners to do research on these issues before choosing the correct taxation option for their LLC. business owners would have to consider the LLC’s needs, circumstances and vision. It is also really important for business owners to stay on top and informed of state and federal changes to laws regarding tax and business. Entrepreneurs should also consider their business expenses and income as well as how their bookkeeping and accounting has to be done.