Many small businesses and sole proprietors ultimately transition to a Limited Liability Company (LLC) to protect their personal assets from risks that happen in the business. Once you file your LLC business paperwork, you may not feel like much has changed and business runs as usual. However, there are notable distinctions between an LLC and sole proprietorship, especially when it comes to filing your taxes this season.
With tax time is well underway, now is the perfect time to learn all about your federal tax obligations as an LLC.*
The LLC is a little different from other business structures because it’s not actually a business classification for the IRS. Instead, the LLC is formed under state law. All this simply means is an LLC business can choose how it should be taxed by the IRS. It can either be taxed as a sole proprietorship (one owner), partnership (two owners) or corporation (any number of owners).
If you don’t make a choice, by default you’ll be taxed as a sole proprietorship (one owner) or partnership (more than one owner). But not to worry, below we cover the tax requirements for all three tax elections.
If you’re a one-member LLC and you haven’t elected to be taxed as a corporation, then the IRS will treat your LLC business like a sole proprietorship. In this case, any profits or loss pass through to you as the owner. And, in addition, they ‘re reported on your personal tax return. The LLC doesn’t pay any federal income tax—although be aware there is an annual franchise tax in some states for an LLC.
To report your LLC income as a sole owner, you will file a Schedule C with your personal tax return. Keep in mind there’s no separation between you and the business (in terms of taxes). So, you’ll report the LLC’s profits on your personal return. That’s true whether or not you actually take those profits or they stay in the business. If money stays in the LLC’s bank account to pay some big planned expenses next year, you’ll still need to pay taxes on those profits on your personal return.
In addition, the IRS considers LLC members self-employed business owners rather than employees. This means that you will need to pay self-employment taxes (calculated on the Schedule SE) and report this annually with your tax return.
Deadline to file
If your LLC has multiple owners, and you haven’t elected to be treated as a corporation, then the IRS will treat your LLC business as a partnership. Like a partnership, the multi-member LLC is considered a pass-through entity and isn’t taxed on its income. Instead, any profits or loss from the LLC are reported on each owner’s personal tax return.
Here’s how it works:
Keep in mind that any LLC owner who actually works or manages the business is considered a self-employed owner. That means they must pay self-employment taxes on their percentage of the profits. If you weren’t active in the business (i.e. your only role was an upfront investment), you may not need to pay self-employment tax on your share of the profits.
Deadline to file
By default, the LLC is a pass-through entity for taxes, but you have the option to be taxed as a corporation with the IRS. This is an advantage if you want to retain a big chunk of money in the business instead of putting it in your own wallet. In order to be taxed as a corporation, you will need to file Form 8832 with the IRS.
If you elect corporate taxation, then your LLC business is a stand-alone entity and is responsible for filing its own tax return and paying the appropriate tax on its profits for the year. The LLC will need to file Form 1120 U.S. Corporation Income Tax Return (it’s Form 1120S if you also choose to be taxed as an S Corporation).
If the LLC fails to file its return on time, the business is responsible and the owners aren’t personally liable. However, it’s best to avoid this situation and make sure your LLC pays its taxes on time.
Deadline to file
If you can’t meet a deadline with the IRS, keep in mind that you still need to file an extension. Knowingly ignoring a deadline will only lead to Failure to File penalties. That said, understand your obligations for your particular business structure, know the deadline and get your filing/extension request in on time. Make tax time a little easier on you and your business.
* Note that this article pertains to U.S. federal taxes. It also contains general information and shouldn’t necessarily replace advice from a tax advisor who is familiar with your specific situation.