How are LLCs Taxed?
Limited Liability Companies (LLCs) can be taxed at the federal, state, and local level just like an individual. However, the biggest difference with an LLC is that LLCs must declare their desired tax treatment at the federal level with the Internal Revenue Service (IRS). The reason that LLCs must declare a different tax treatment between the state and federal level is that the idea of an LLC is really a state law concept. That means that the IRS does not have a defined way to tax LLCs. So, when an owner registers their LLC, they will need to declare their tax treatment with the IRS.
DEFAULT TAX TREATMENTS
If an entity are a single-member LLC, the IRS will default to taxing the business like a sole proprietorship. This isn’t necessarily a bad thing and some owners prefer this tax treatment. The general rule of thumb is that if the business owner is making less than a full-time wage (around $48,000) from their business, then a sole proprietorship may be the best way for the owner to be taxed.
If an entity are a multi-member LLC, the IRS will default to taxing the business like a partnership. The same general rule of thumb applies here.
S-CORP TAX TREATMENT
If an owner does not want to be taxed as a sole proprietorship or a partnership, they can elect to be taxed as a subchapter S-corporation. For some companies, S-corp taxation comes with tax advantages. For instance, if the business owner is making more than a full-time wage. The main tax advantage is that the owner still gets the benefit of pass-through taxation.
Pass-through taxation means that an owner does not have to pay taxes at both the individual level and the company level. Traditionally, corporations are taxed at the company level, and then when the owner takes money out of the business, they are taxed on that money as well. That is referred to as double taxation - an owner does not want that unless they have to. That is why many business owners select S-corp treatment for their LLCs.
So how does an owner elect for S-corp taxation?
When an owner registers for their Employer Identification Number, or EIN, with the IRS, the owner can simply check a box for what they want their tax treatment to be. But checking that box will not be enough, the owner may also need to fill out Form 2553 and mail it to the IRS.
For more information on LLC tax treatment we recommend consulting a CPA or connecting with us to connect you with one. Contact Curington Law, LLC at 312 803-1755 or online.