When a limited liability company (LLC) is formed, it is because business owners are looking to protect themselves from personal liability. Forming an LLC not only provides liability protection for its owners (called members) but also allows these members to be taxed at their personal tax rates.
The method in which an LLC pays income tax varies on the makeup of the members. If there is one member or several members, then taxation will be different, but the LLC can also elect to be treated as a different type of business for tax purposes.
Starting an LLC can be done by registering with the state in which you plan to do business, filing Articles of Organization, and paying a fee. Despite that, an LLC is a legal business entity, the Internal Revenue Service does not recognize LLCs for tax purposes. This means that LLCs pay taxes differently than other types of businesses.
How are Delaware LLCs Taxed?
Limited Liability Companies are not separate tax entities similar to how corporations are. Instead, the IRS calls LLCs a pass-through entity. This means that an LLC is taxed similar to that of a partnership or sole proprietorship, through each individual owner’s tax rates.
Income Taxes
Single Owner LLCs
Single owner LLCs are treated exactly the same as a sole proprietorship for tax purposes. This means that the LLC will never pay taxes as a corporation, and does not need to file a business tax return with the IRS.
In order to calculate the net income from an LLC, you will need to do so with a Schedule C form. The net income from the Schedule C will then be brought over to the personal tax return using Form 1040 or 1040-SR.
Multi Owner LLCs
There are two methods by which you can file an annual report in Delaware, online or by mail. In Delaware, your Annual Report will be due by February 15 each year, while in other states you may only need to file every two years.
- File an informational return with the IRS using Form 1065
- Each member will receive a Schedule K-1 form. This will show all the profit or loss of the partnership.
- The Schedule K-1 will hold a good amount of information, which must be transferred to the Schedule E- Supplemental income form. Here there will be a breakdown of your income into different sections, which each has a specific place on this form.
- Take the information from the Schedule E, and input it into Form 1040 or 1040-SR.
Electing Taxation
There are two options when it comes to electing taxation as an LLC. The first is if you will need to keep a large number of profits in your LLC. This is called retained earnings. If this is the case, then you may benefit from electing corporate taxation, which can be done by any LLC simply by filing an IRS Form 8832.
When you elect corporate taxation, you will fall into the same tax rate as all regular “C” corporations. C Corporations are taxed at a flat 21% rate on all profits. This rate is lower than all top three individual income tax rates which range from 32% to 37%.
Who Should Consider Corporate Taxation?
If you make enough income to qualify you for a personal tax rate that is higher than 21%, you may save money by electing corporate taxation. This might seem appealing for some, but there is a catch. ANy money distributed from a C corporation to its owners will be subject to double taxation. This means that you will first pay the 21% corporate tax rate, followed by an individual income tax on capital gains as well.
Although your retained earnings are not subject to double taxation, sometimes electing corporate taxation can allow an LLC to offer various tax-advantaged fringe benefits to its owners and employees. Electing corporate taxation may also facilitate stock options, and stock ownership plans, which are not subject to double taxation.
What is Tax Deductible for an LLC?
There are many expenses that LLCs must pay for, this might include health benefits, salaries, and rent. One great part of an LLC is that some of these legitimate expenses are tax-deductible which can help you to lower the profits you are required to show to the IRS. These deductible expenses might include:
- Start-up costs
- Travel
- Equipment
- Moving
- Salaries
- Health benefits
- Marketing
Other LLC Taxes
State Taxes
Although it depends from state to state, most states will tax LLC profits similar to how the IRS does. In Delaware, the corporate tax is a flat 6% of all taxable income. This is only payable if your LLC is taxed as a corporation.
Self Employment Taxes
Once again, self-employment taxes will vary from state to state. In Delaware, LLC members who take profits from the LLC will need to pay a self-employment tax. This tax is also known as FICA, Social Security, or Medicare tax. Any earnings that are withdrawn from your LLC will be entitled to self-employment taxes, which are currently at a rate of 15.3 percent in Delaware.
How LLCs Pay State Income Tax
Because members of an LLC pay personal income taxes on their personal tax returns, an LLC will not pay state income tax. Instead, this will only be reflected on each individual member’s taxes. The only difference in this is if an LLC elects to be taxed as a corporation.