LLCs are not recognized by the U.S. Internal Revenue Code as being a distinct taxable entity, and are instead taxed as a sole proprietorship, partnership, C corporation or S corporation, and which one they select, comes down to several different factors. When it comes to their tax treatment, LLCs have a lot of flexibility.
Let’s look at the filing requirements of the 4 main LLC entity’s:
Single-Member LLCs
In this case, the LLCs income will be attributed to the single member who is obliged to report it on their 1040 tax return. If active trade or business is engaged in by the LLC, then that single member will be treated as being self-employed, and must pay a self-employment tax on all taxable income derived from it. This is paid in place of Social Security and Medicare taxes.
Multiple member LLCs
Treated as partnerships by the IRS, LLCs with two or more members are not taxed; instead, members must submit the Form 1065 informational tax return to the IRS by the 15th April every year. The allocation of its income to members must also be reported in Schedule K-1, and copies of said schedule must be distributed to all members.
Multiple member LLCs will attribute their income in proportion to the entitlement to LLC profits, which is typically each member’s ownership percentage in the LLC. Each member must pay taxes on their attributed share of LLC income using Form 1040, whether any of it was distributed, or not. Each member must also pay self-employment tax on their allocated share if the LLC engages in active trade or business.
C Corporation
LLCs have the option of electing themselves as a C corporation, and this is done by completing and filing Form 8832 with the IRS. If the LLC is to be taxed as a C corporation, it must go on to file a Form 1120 tax return by the 15th of March, annually, and its income will be taxed at corporate tax rates. Each member of the LLC will then be taxed at individual income tax rates, based upon the income they receive from the LLC.
C corporation LLCs will not be taxed on any income from the LLC that isn’t distributed to them, and they are not assessed for self-employment taxes. Each member must also report dividends using a Form 1040.
S Corporation
If an LLC qualifies, it can choose to be taxed as an S corporation, and this is done by filing IRS Form 2553. While the LLC itself will not be subject to taxes, it must still file Form 1120S by the 15th March every year, and all members will be taxed at individual income tax rates. However, this is only on income that they actually receive from the LLC.
Members of an LLC that actively engages in trade or business, will find themselves liable for self-employment tax on any income received from it, and must report their incomes using Form 1040.
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