Did you go into business to do taxes? A select few business owners do. So it is no surprise that taxes are one of the most confusing tasks a business owner faces. Especially for 1st-generation entrepreneurs. Understanding how the IRS taxes your LLC is one of the first steps to making sure you don’t end up in trouble with them.
Let’s take a look at what an LLC is and how the IRS will tax your LLC.
What is a Limited Liability Company?
A limited liability company (LLC) is an independent legal entity. It exists separately from its owner(s). This structure offers limited liability to whoever owns it. The owners are also known as members. Members are not held personally liable for the company’s debts or liabilities.
An LLC is set up at the state level and not at the federal level with the IRS. Most states do not restrict ownership. This means that the members can be individuals, corporations, and even other LLCs. It is important to check with your state to see the specific requirements for setting up an LLC there. Certain businesses cannot be an LLC, such as banks and insurance companies.
There are two types of LLCs. Those with a single member, known as a single-member LLC or disregarded entity. Then there are LLCs with multiple members also known as a Partnership. The number of members determines the default of how the IRS will treat the LLC.
The IRS treats a single-member LLC as a disregarded entity, part of the owner’s return. The IRS will treat a domestic LLC with multiple members as a partnership. An LLC with one member or multiple has the option to elect for the IRS to tax them as a corporation.
How is an LLC Taxed?
The IRS does not recognize a single-member LLC as an entity. This is because the IRS considers single-member LLCs to be sole proprietors. Single-member LLCs show the profit and loss of the business on Schedule C of the 1040. This income or loss flows through to Schedule 1 and then on page 1 of the 1040. LLCs renting properties out will have their income and expenses reported on Schedule E.
If there is a net profit of $400 in the business a single-member LLC must file a tax return. This is also when self-employment tax kicks in. Self-employment tax is a business owner’s contribution to social security and medicare. It comes out to be roughly 15.3% of net profits.
Let’s say the LLC has a net profit of $100,000. They will pay almost $15,300 in self-employment tax when they file their 1040.
Members of a multiple-member LLC also pay self-employment tax.
They report their income on Form 1065, Partnership tax return. Then each member receives a K-1, which shows their share of income and expenses. The K-1 is then used to report the income on their individual return.
The IRS requires LLC owners to pay income and self-employment tax payments quarterly. These estimated tax payments pay the owner’s tax liability during the year. The owner can avoid underpayment and failure to pay penalties when they make these payments.
Sinking under a tax penalty or bill can feel like death. Not understanding how the IRS taxes your LLC can lead you to that death. Having a good understanding is critical to the financial health of your business. If you are already sinking tune in to the Tax Relief with Timalyn Bowens podcast to see what your options are to get back in good graces with the IRS. Back taxes shouldn’t ruin your life.