LLC is a business structure that's popular with small-business owners. An LLC offers the benefits of a corporation (separation of personal assets from business assets) without the corporate formalities (such as holding annual meetings and keeping detailed records). What about the tax classification for LLC?
- An LLC tax classification determines how the company will be taxed and what its tax obligations are.
- LLCs do not have a required tax classification. They can choose to be taxed as a sole proprietorship, partnership, C corporation, or S corporation depending on the number of members or what they agree on.
- When deciding how your LLC will be taxed, you'll need to consider how much your business makes and how much it spends on overhead costs like advertising and utilities.
What is an LLC?
An LLC is a limited liability company. It combines the advantages of a partnership with those of a corporation. The owners (called members) have limited liability; meaning they can't be sued personally if the company gets sued.
And if they do get sued, they don't have to worry about losing their personal savings or property to pay off debts from lawsuits against their business. An LLC can be formed by filing articles of organization, which must include the name of the LLC and the state where it will be registered.
LLCs Have Separate Legal Existence from Their Owners
Meanwhile, like corporations, LLCs have separate legal existence from their owners, which means that if one member leaves the company, it doesn't dissolve and liquidate; it simply retains its legal status as an independent company owned by other people.
What Is a Tax Classification for an LLC?
LLCs do not have a required tax classification. The IRS allows you to choose how your LLC will be taxed. You can be taxed as a sole proprietorship, partnership, or corporation.
The one you choose depends on what you want for your business and whether your state imposes any restrictions or limitations on the choice of entity.
By default, the IRS has pass-through taxation to limited liability companies. This means that income from the company is passed through to its owner's individual tax returns. The owners pay tax on their share of the profits from the business.
This is different from C corporations which are subjected to double taxation; they pay corporation tax on their profits before distributing dividends to shareholders who pay personal income tax on those dividends.
1. Sole Proprietorship
A sole proprietorship is a business owned and operated by an individual. It has no legal distinction between the owner and the business itself, so the owner's personal assets are at risk if the business fails.
Many small businesses are sole proprietorships, including most self-employed people such as writers, contractors, and consultants. The biggest advantage of a sole proprietorship is that it's easy to start and operate.
Taxed as A Sole Proprietorship
The first thing to understand is that most states allow LLCs to choose how they will be taxed. The decision will have implications on how much income tax you'll owe as well as how you file your taxes.
Unlike C corporations, LLCs do not pay taxes at the entity level. Instead, they pass through all profits or losses to their owners, who record them on their personal tax returns.
A single member LLC that does not elect out of taxation as a partnership is classified as a disregarded entity for federal income tax purposes (this means that it does not file its own separate return). Instead, all income and expenses are reported on the owner's personal tax return. This type of LLC is known as a "disregarded entity."
Single Member LLC
For example, if you are an attorney who owns a single-member LLC that provides legal services to clients, all of the income from that business is reported on Schedule C of your Form 1040.
You then deduct any business expenses from your gross income to arrive at net profit or loss. The net profit or loss is then included on line 12 of Form 1040 (or line 21 for short form).
A partnership is a business where two or more people share ownership of the business. Each owner has an ownership stake in the company and its profits and losses.
Partnerships don't pay income tax themselves; it gets passed through to the partners who then pay taxes on their share of profits at their personal income tax rate.
Taxed as A Partnership
A multi-member LLC can also choose to be taxed as a partnership, which means it will have to file Form 1065 with the IRS. This form is used to report income and expenses for all partnerships that have two or more owners. The partnership does not pay taxes itself, but each partner reports their share of the profits and losses on their individual tax returns.
It is the Common Form of Taxation for Larger Businesses
This is the most common form of taxation for larger businesses with multiple owners.
However, this option also requires significant ongoing record-keeping and compliance obligations such as maintaining books & records to name just a few.
3. S Corporations
An S corporation is a special type of corporation created by the IRS to avoid double taxation.
Double taxation occurs when all profits are first taxed at the corporate level, then again at the shareholder level when they receive dividends from their shares in the company- in this case, the S corporation’s shareholders would be taxed twice if they were C corporations.
Taxed as an S Corporation
S corporations do not pay federal income tax; instead, it passes through their profits and losses to their shareholders, who report these amounts on their personal income tax returns (Forms 1040). However, the IRS has strict rules about who can be taxed as an S Corporation:
4. C Corporation
A corporation is an entity that is separate from its owners. Corporations are typically formed by filing articles of incorporation with the state, which sets up the corporation’s existence as a legal entity. A corporation is owned by shareholders and can be public (traded on a stock exchange) or private (not traded on an exchange).
Filing Taxes as a C Corporation
When you file taxes as a C corporation, you pay taxes on your profits at both the corporate level and at the individual level when those profits are distributed to shareholders in the form of dividends.
For example, if you have $100,000 in net income after all expenses are paid, you will pay at the corporate level, say between 15% and 35%, depending on your state), then you're left with about $80,000 in profits which will be taxed again at individual rates.
What Are the Different LLC Classifications?
There are several different classifications of LLCs you can choose from when filing your articles of organization with your state's secretary of state or equivalent agency. These include:
Single-member LLCs are for sole proprietorships or solo entrepreneurs who want to run their business under an LLC but don't have any partners or employees. They're often used by freelancers and consultants who want to protect their personal assets from liability.
If you have more than one owner in your business, then it's classified as a multi-member LLC. You can have anywhere from two to 100 owners in your business, depending on how many owners your state allows for that particular type of entity.
Member-managed LLC. This is a business entity where all members manage the company. There are no managers, just members who are involved in the day-to-day operations of the business.
Manager-member LLC. This type of entity is similar to a member-managed LLC except that an outside manager must be hired by the members to oversee the day-to-day operations of the business. Managers can also be employees or independent contractors who receive compensation for their services as outside managers.
A domestic limited liability company (LLC) is registered in just one state where it does business. Domestic LLCs have fewer regulations than foreign LLCs, but they must follow all state laws regarding formation, operation, dissolution, and taxation.
A foreign limited liability company (LLC) is registered in one state but conducts business across multiple states or internationally. Foreign LLCs have more regulations than domestic ones because they operate in multiple jurisdictions across borders or oceans.
A series LLC is a way to group your business interests into separate and distinct entities. It allows you to have multiple businesses under one umbrella.
A series LLC can be used for various purposes, including real estate investment and holding companies. It does not have to be used for multiple businesses; it could be used by one person with different assets or even just one property.
How Do I Know If My LLC Is an S Corp or C Corp?
If you have an LLC, but don't know whether it's classified as an S corporation or a C corporation, that's not a problem. You can easily check with the IRS to find out how your business is classified.
Tax Professional Can Help
All you need to do is fill out the appropriate IRS form, then file it with your state and federal tax returns. If you're not sure which form to use, check with your accountant or tax professional before filing.
Lastly, if there are still some uncertainties left, we recommend seeking advice from other top formation services and registered agent services out there. Here are some of the most trusted:
Trusted Business Formation Services
Despite only doing business since 2015, their 100% positive reviews are speaking for themselves. Swyft Filings offers one of the best refund policies in the industry. On a bonus side the company also has no processing or cancellation fee for your refund. It is a great company to consider when looking to designate a registered agent service for your business.
BizFilings takes you through the whole process from quality check to post-incorporation and also offers on-going support. You can choose various payment plans based on the features you want and your budget. The features in the higher-end packages are also available in the lower-end packages but at an additional fee. With an A+ rating with the BBB, BizFilings is a trusted online formation service.
When compared to other formation services, SunDoc Filings provides volume discounts for multiple states and entities and equally amazing customer support. However, if you want a service that will save you money, you may find other services in the market that cost less. Also, you may not choose SunDoc Filings if you are looking for a service with payment packages with tons of features and free registered agent service.
This is one of the most reputable companies you can pick as your registered agent service. Inc Authority has enough experience in the field, having been founded in the 1980s. Its free payment package stands out in what they offer. Loads of positive customer reviews speek for themselves how satisfied and happy with their services and their LLC formation speed their clients are.
MyCorporation is known for offering a fast LLC formation process. If you wish to speed up the process turnaround time, you can use their expedited service, reducing the process from weeks to a few days, thoug for a fee. Nonetheless, MyCorporation is an excellent pick as your registered agent. It offers numerous payment packages with various features depending on your budget.