It’s hard to think of another five-letter word that brings as much fear, confusion and hatred as the word taxes. LLC business owners know firsthand how frustrating and confusing taxes can be. After all, LLC taxes can be complex, and if not filed or planned for, costly. As a business owner, the amount owed in tax influences how much money you have left over to invest and grow your business. Understanding how LLC taxes work can be essential to your business and personal finances.
How LLCs pay taxes
An LLC is treated as a pass-through entity for tax purposes. The members, or owners, of the LLC pay tax on the income they earn operating the business, but the business itself doesn’t pay tax. The LLC owners must claim the income or loss when they file taxes, and they pay a normal income tax on any profit earned while operating the LLC.
However, this process can become more complicated depending on the classification of the LLC. For example, the IRS allows you to classify your LLC business as a C-corporation, partnership or as part of the owner’s tax return. Your method of tax classifications affects tax preparation.
LLC taxes pertain to the profit earned on the business, not the revenue a business generated. For example, if you’re an electrician and own a sole proprietorship LLC, you may bill your customers a total of $350,000 for the work you completed throughout the year. However, if you’ve spent $200,000 on expenses, you will only pay taxes on $150,000.
Other taxes, such as self-employment tax and social security tax, must also be taken into consideration on the income you earn through your LLC. These taxes are often forgotten and can catch new LLC business owners by surprise.
What are the tax advantages of an LLC?
Owning an LLC comes with tax benefits. Some of the most sought-after tax advantages of an LLC include:
- Pass through taxes: As an LLC business owner, the profit you earn on your business will be taxed as personal income. This benefit can save you a significant amount of money.
- Tax deductions: As an LLC business owner, you pay tax on profit you earn. Profit is defined as the money you have left over from your revenue after your expenses. Plenty of expenses count as tax-deductible expenses, which can ultimately reduce your tax liability. Examples include gas, car payments, internet, electricity, rent for your office, electronics such as computer equipment and marketing activities. You can reduce your tax liability by investing in your LLC.
- Flexibility with taxes: As an LLC business owner, you can elect how your business is taxed. For example, you can choose to be taxed as an S-corporation, C-corporation, sole proprietorship or partnership.
What are the tax disadvantages of an LLC?
Even though there are significant tax advantages of an LLC, disadvantages exist. Such tax disadvantages include:
- Self-employment tax: Self-employment LLC taxes can be overlooked by new LLC business owners. If you’ve been a W2 employee your entire life and start an LLC, self-employment tax may not be on your radar. But self-employment LLC tax is a reality and something you should consider and account for so it doesn’t take you by surprise when your taxes are due.
- Documentation for write-offs: Tax deductions are a major LLC tax benefit. However, managing these deductions can add extra paperwork to your day-to-day routine. Keeping a thorough record of all your receipts for your business expenses is required, as you may get audited by the IRS and will need to prove your business expenses.
- Profit distribution: The profits your LLC business generates are automatically included as income and must be recorded when you file taxes, whereas C-corporations do not automatically distribute their profits. With an LLC, you pay taxes on the recorded profits per year, even if you’re forecasting profits to reduce or decline in the future.
When are LLC taxes due?
It’s important to note that not all LLCs are classified the same. The IRS does not have a one-size-fits-all approach to when taxes are due. The due date of your taxes depends on how your business is classified.
For partnerships, S-corporations and multi-entity LLCs, expect to pay your taxes no later than March 15 of every year. If your LLC is a C-corporation, your taxes will be due by April 15.
How to file taxes for an LLC
How is an LLC taxed? Filing taxes on an LLC depends on the type of entity you elect.
Income taxes for single-member LLC taxes
Single-member LLC taxes are straightforward. The IRS does not differentiate the LLC from the owner. Therefore, the LLC business owner files the income they earn on their personal tax return.
Income taxes for multi-member LLC taxes
Multi-member LLCs may require the business partners to fill out Form 1040, Schedule C, Schedule E and/or Form 1065. Multi-member LLCs do not pay taxes as a company; they pay tax on the partner level.
LLC payroll taxes
LLCs can also have employees. If so, the LLC must pay payroll taxes. Payroll taxes include the employer’s responsibility for social security taxes, unemployment taxes and Medicare taxes. Payroll taxes must be paid when an LLC has an employee. Small business LLCs may choose to hire independent contractors instead of employees to protect themselves from the LLC payroll tax they’d face having employees on the payroll. Payroll taxes can be filed using IRS forms 940 and 941.
LLC self-employment taxes
As a self-employed LLC business owner, you cannot forget to pay self-employment taxes. Self-employment taxes include social security taxes and Medicare taxes. The IRS reserves the right to update these percentages when they update the tax rate yearly. As a reminder, if you are a W2 employee, your employer is covering part of your social security and medicare tax. If you are the business owner, you must pay self-employment tax as both the employee and the employer.
LLC sales taxes
LLCs must also pay and collect sales tax where appropriate. Some states do not have a sales tax, but the vast majority of states do. It’s important to know the specific sales tax laws imposed by the state(s) where your business operates.
Nothing to Fear
LLC taxes are not something to fear as long as you are educated and prepared. The biggest blindspot many LLC business owners make is not allocating enough money to pay the self-employment tax when filing taxes for the year. As long as you have this on your radar all throughout the year, accrue accordingly and keep detailed records of your income and expenses, you should be prepared to file taxes. An LLC provides plenty of tax advantages for business owners.
What does an LLC not protect you from?
An LLC offers no protection if an owner commits a wrongful act that brings pain or suffering to someone. For example, one cannot commit an assault and hide behind their LLC for legal protection.
Is it better to be a 1099 or LLC?
It’s not better or worse to be a 1099 or an LLC. It’s entirely dependent on what you’re trying to do. LLCs offer liability protection for the owners, which is not offered with 1099 income.
Is LLC income taxed twice?
No. In fact, that’s one of the greatest benefits of an LLC. LLCs are considered pass-throughs for tax purposes.