Thinking about forming your small business as an LLC? If so, you’re probably curious about how doing so would affect your tax situation. And rightly so. While forming an LLC is a big, important step in protecting your personal assets when owning a business, it also adds extra considerations — and complications — on the tax front.
Here are some business tax basics entrepreneurs should know before they form an LLC.
What’s an LLC?
In a nutshell, an LLC is a type of corporate business structure in which owners are protected from personal liability to their business’ debts or claims. In other words, when used correctly, the LLC structure means owners only risk money they’ve put into their company — not their personal assets.
What an LLC Can Mean for My Taxes
The IRS doesn’t recognize an LLC as a distinct tax entity — technically it’s “disregarded.” That’s because the way an LLC is taxed depends on other factors, including whether it’s a single-member or a multi-member entity. There are four ways this can look:
Sole Proprietorship. When taxed as a sole proprietorship, an LLC’s profits all flows through to your personal tax return. This means you’ll need to pay self-employment tax.
Self-employment tax, or the FICA tax rate, is your Social Security and Medicare taxes – in 2019, it’s 15.3 percent of your earnings. If you’re employed in a “regular” job, your employer pays half of this, leaving you on the hook for 6.2 percent in Social Security taxes for the first $132,900 of your wages paid, and 2.9 percent in Medicare taxes up to $200,000 of your earnings. But when you’re operating as a sole proprietor, you pay the entire 15.3 percent yourself.
Partnership. If taxed as a partnership, your LLC taxes will look very similar to the above, with profits taxed at the member level (but for multiple members).
S Corporation. S Corporations are also considered “pass-through” entities, which means your LLC’s business income will still be taxed on the owners’ individual tax returns.
However, the S Corp format offers some optimizations for LLCs that choose this tax structure, including designating some income as a “distribution” to save on the employment taxes mentioned above. Check out how this could affect your taxes with our S Corporation Tax Calculator.
C Corporation. In terms of taxes, C Corporations are a little trickier. If you form an LLC and are taxed as a C Corporation, the company itself will pay taxes on profits — and members will be responsible for paying their own income taxes on distributions as well. As a result, your small business will effectively be subject to double taxation.
State Income Tax for LLCs
State income taxes for your LLC will depend on the state you form your small business in. To figure out how your LLC will be taxed from your state, visit the respective state department of revenue where your company does business.
Most states are in step with federal income tax liability as a basis in determining your business net income, but some states have made their own tweaks. Some states also add their own spins on exclusions and deductions available.
LLC Taxes Can Be Complicated
While LLCs provide an added layer of personal liability protection, the structure can also complicate matters when it comes to tax time.
For instance, should your small business ever need financing from investors, some of them (such as startup funds) aren’t able to invest in LLCs. Plus, LLCs taxed as partnerships usually include provisions on how and when cash can be distributed to owners to cover taxes they must pay on the income.
This could make reinvesting in the business more complicated. Additionally, if your business operates in other states, you might be subject to income tax there as well.
If you’d like to learn about LLC tax information or get help with your business taxes, our team of tax professionals can assist you in filing your business taxes with ease.