How is an LLC Taxed?

By default, LLCs are treated as a pass-through entity for federal income tax purposes. This means LLCs don't pay federal income taxes at the business level. LLC income passes through to members' personal income tax returns based on their percentage of ownership as it's laid out in the LLC operating agreement. The income is then subject to individual income tax rates.

Payments made to members are called distributions or draws. Distributions are subject to self-employment taxes. For some LLCs, it might make sense to elect S corporation tax status to reduce self-employment taxes.

Single-Member LLC Taxes

Single-member LLCs are taxed by the IRS as “Disregarded Entities.” This just means the IRS ignores the structure of your business (i.e., the fact that it's a single-member LLC) and taxes you like it does a sole proprietorship. The LLC’s income is reported on your personal tax return at the end of the year.

With your LLC income, you can pay yourself with a distribution. You will have to pay self-employment taxes on your distribution but, because you already paid income tax on the LLC’s total profits, you do not have to pay income tax on the distribution. This process is explained more in our How Do I Pay Myself From My LLC guide.

Multi-Member LLC Taxes

A multi-member LLC is typically taxed as a partnership by the IRS. This means that LLCs don't pay federal income taxes to the IRS and all profits are passed through to the members of the LLC as per the partnership operating agreement. The members of the LLC then pay the taxes to the IRS on their individual tax returns.

Like single-member LLCs, each owner in a multi-member LLC can take a distribution from their share of the LLC’s profits. This process is explained more in our How Do I Pay Myself From My LLC guide.

For most people starting an LLC, the default tax structures—“disregarded entity” for single-member LLCs or “partnership” for multi-member LLCs—are probably the most appropriate. These are the standard tax structures for limited liability companies and do not require a special election when forming.

However, under certain circumstances, both single-member LLCs and multi-member LLCs can also elect to be taxed like a corporation. The two corporate tax classifications are C corporation (C corp) and S Corporation (S corp).

A C corporation pays taxes on gross income minus all operating expenses. They then distribute profits to shareholders, and shareholders pay income tax on the dividends. This is also known as "double-taxation.”

An S corporation allows the member(s) of a company to save on taxes. It is a tax classification with specific rules that can be beneficial to your company if your business earnings are significant. However, before making a decision, it’s important to understand the basics of an S corp and what changes may be in store for your business if you decide to elect S corp status.

Selecting these tax structures can be done when you apply for an EIN (Employer Identification Number) for your LLC or at a later time.

Regardless of which tax designation you elect for your LLC, you still have to file with the IRS.

All owners will have to fill out Form 1040—your individual income tax return—and its appropriate schedules:

• Schedule C: The form for reporting income specifically from your business.

• Schedule SE: The form for filing and paying your self-employment taxes.

• Schedule E: The form for reporting any income from rental properties and other investments.

Multi-member LLCs and special entities will need to file more than that. Partnerships, in addition to Form 1040, must also file the following:

• Form 1065: The form used to report your business’s gains and losses.

• Schedule K-1: The form for reporting your share of the profits as an individual owner.

Check out our guide to filing federal LLC taxes to see a full list of necessary forms for both single-member LLCs and multi-member LLCs.

Because LLCs are typically “pass-through” entities, they do not have to pay separate state taxes. That is, the individual members pay state taxes; not the LLC itself.

Here are some of the common forms of state tax:

• Franchise Tax: Some states require this tax, which is based on how much an LLC earns per year.

• Sales and Use Tax: If you sell physical products, consumers pay this tax to you and you pay this tax to your respective state or local governments.

• Gross Receipts Tax: While similar to a sales tax, a gross receipts tax is paid by the seller rather than the buyer.

• Withholding Tax: This is income that is withheld from employee paychecks and paid to the government.

• Unemployment Insurance (UI) Tax: UI is used for unemployment benefits. Tax rates are set by state law.

You can find out more in our detailed guide to state LLC taxes. You can also read our How to Form an LLC guides to learn more about LLC taxes by state.

As a business, you are able to deduct certain expenses from your taxes. The IRS says that a deductible business expense is both “ordinary and necessary.” In other words, your business can write off any expenses that help your business succeed.

Tax-deductible expenses can include a variety of purchases; these are just a few common examples:

• Office supplies
• Rent and general maintenance
• Licenses and permits
• Advertising
• Insurance

Some expenses, such as travel and entertainment-related purchases, are harder to deduct. These categories have spending limits, additional terms, or must be capitalized.

Of course, expenses are only deductible if they are “appropriate.” You might think a rooftop Jacuzzi is important for maintaining your business, but the IRS probably won’t agree with you unless you’re a Jacuzzi-selling business.

You can check out our business expense guide for a complete list of basic and complex deductions.

It’s important to make sure your books are in order to protect your corporate veil.

Separate your personal matters from your business expenses as much as possible. You can do this by:

• Opening a separate business bank account.

• Obtaining a business credit card for work-related purchases.

• Creating a solid bookkeeping system - A high-quality accounting program can help keep track of your expenses and make the process simple and relatively pain-free. You can also hire an accountant.

Check out our Guide to Small Business Bookkeeping to learn more.