How Do Limited Liability Companies (LLCs) Pay Taxes?

When you start a business and form a limited liability company (LLC), you step into a brand new world. One major hurdle is the dreaded T word – taxes. Nobody enjoys taxes, and as an LLC owner the tax maze is particularly complex and tough to navigate. 

Fortunately, this handy guide lays out all you need to know to jump through the hoops of LLC taxation and put your business on the path to success. 

LLC Taxation

LLCs are different from other types of business entities in that they can choose how to be taxed.  

By default, if your LLC has only one owner, or member, and you make no choice regarding taxation, your LLC is taxed as a sole proprietorship. This means that for tax purposes, the LLC is a disregarded entity and is not taxed. Profits and losses instead pass through to the member to be reported on their personal Schedule C tax return. 

If the LLC has more than one member, the default taxation is as a general partnership. The LLC is still not taxed, though it must file Form 1065, the U.S. Return of Partnership Income form, for informational purposes. Profits and losses pass through to the members based on their ownership percentages and gets reported on their personal tax returns.

Alternatively, LLC members can elect to have their business taxed as either an S-Corporation or a C-Corporation. This should only be done if they deem it financially beneficial to do so. 

If members choose to be taxed as a C-Corp, the LLC is taxed at the corporate income tax rate at the federal and state levels. LLC members pay taxes on dividends received and personal taxes on their salary.

If members choose S-Corp, the LLC itself is not taxed, but must file form 1120S, the U.S. Income Tax Return for an S-Corp form. Revenues again pass through to the owners, who must receive a “reasonable salary,” as defined by the IRS, before taking any profit distributions from the LLC. You’ll be responsible for employment taxes on that salary.

The main reason to choose S-Corp status is to avoid self-employment taxes. If your LLC is taxed as a sole proprietorship or partnership, members are responsible for self-employment taxes, which are discussed further below.

The IRS has several qualifications for S-Corp status eligibility. The company must:

• Be a domestic corporation
• Have only allowable shareholders
  • May be individuals, certain trusts, and estates and;
  • May not be partnerships, corporations or non-resident alien shareholders
• Have no more than 100 shareholders
• Have only one class of stock
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations)

The decision on tax status is best made with the advice of a tax advisor. If you choose either of the corporation statuses, it’s a good idea to have your tax advisor handle your taxes, as they can get very complicated.

Franchise Taxes

Some states charge LLCs what’s called a franchise tax, known as a business privilege tax in some states. The tax is not a tax on franchise businesses but a tax on businesses for the right to do business in that state. California, for example, has an $800 annual tax all LLCs must pay.

Check with your state to learn about annual tax requirements and be sure to check due dates. Failing to pay those taxes can result in penalties or even the dissolution of your LLC.

Self-Employment Taxes

As mentioned above, members of an LLC taxed as a sole proprietorship or partnership are subject to self-employment taxes. 

Self-employment taxes go to Social Security and Medicare, which is what you would normally pay if you were an employee. The rate is 15.3%, of which 12.4% goes to Social Security and 2.9% to Medicare.

For 2022, income up to $147,000 is subject to the Social Security part of the tax. The Medicare part has no wage limit, but income over $200,000 is subject to an additional 0.9% Medicare tax.

Earnings subject to self-employment taxes are reported on Schedule SE. To learn more about self-employment taxes, visit the IRS website. 

Income Tax Withholdings and Payroll Taxes

If you have employees, you’re required to withhold income taxes and payroll taxes and pay employer-paid payroll taxes. Income tax is paid by the employee at the federal, state, and local levels. 

The amount withheld for federal income tax depends on the employee’s W-4, which specifies the employee’s filing status, dependents, and withholding requests. To calculate federal income tax withholdings, refer to IRS Publication 15. 

States and localities may require that employees fill out a state or local form similar to the W-4, which you can use to calculate those taxes, or they may have a flat amount that you’re required to withhold. 

Payroll taxes are taxes withheld from employee paychecks to fund Social Security and Medicare, similar to your self-employment taxes, and employers also make payroll tax contributions. These are known as FICA taxes, which stands for Federal Insurance Contributions Act. 

The Social Security tax is paid by the employee and the employer at 6.2% of the employee’s total compensation, and the Medicare tax is also paid by both, at a rate of 1.45% of employee compensation.

The same wage limits for self-employment taxes apply to FICA taxes. 

Employers are also required to pay taxes under the Federal Unemployment Tax Act (FUTA) and the State Unemployment Tax Act (SUTA). The FUTA tax rate is 6% and has a taxable wage base of $7,000, while SUTA tax rates vary by state. 

To pay the federal income taxes withheld and FICA taxes, use Form 941, the Employer’s Quarterly Federal Tax Return. To pay FUTA taxes, use Form 940, the Employer’s Annual Federal Unemployment Tax Return. 

Check with your state and local governments for payment requirements for all state and local withheld taxes and payroll taxes.

Sales Tax

If your company sells taxable goods or services, you’ll need to obtain a sales tax permit in order to collect and pay sales taxes, if your state has a sales tax. Some localities also have sales taxes. Check with your state and local governments to learn all the details about sales taxes and required permits. 

If you’ve recently formed a limited liability company (LLC), you may have some tax questions. One of the most important is about when LLC taxes are due. The answer is that it depends on how your LLC is taxed. 

When are LLC Taxes Due?

If you have a single-member LLC and have not elected to be taxed as a corporation, the answer is simple. Your LLC income passes through to you and taxes are paid on your personal tax return, due April 15^th. 

For multi-member LLCs taxed as partnerships or LLCs (whether single-member or multi-member) you will have to choose whether your accounting will be based on a calendar year, which is January to December, or a fiscal year. A fiscal year is a 12-month period starting from any date you choose. For example, your LLC’s fiscal year could run from May 1^st to April 30^th. 

If you choose to be taxed as a C-Corp and use a calendar year, your taxes will be due on or around April 15^th. If you use a fiscal year, your taxes will be due on the 15th day of the 4th month after your fiscal year ends. For example, if your fiscal year ends April 30^th, your taxes will be due August 15^th. 

If you choose to be taxed as an S-Corp, you have to use a calendar year and your taxes, which are paid by filing your personal tax return, will be due March 15^th.

If you’re taxed as a partnership, if you use a calendar year, your taxes will be due March 15^th. If you use a fiscal year, taxes will be due on the 15th day of the 4^th month after the end of your fiscal year, as with a C-Corp. 

Do LLCs Get a 1099 During Tax Time?

The answer is – it depends. Whether you get a 1099 depends on how you’ve chosen to have your LLC taxed. You also may need to issue 1099s.

Receiving 1099s

Keep in mind, if you are a single-member LLC taxed as a sole proprietorship or a multi-member LLC taxed as a partnership and provide services to another company as an independent contractor, that company will issue you a 1099 reporting the amount your company has been paid.

If you have elected to be taxed as a corporation, with either S or C status, you will not receive a 1099. But you will of course have to report the income. In an S-Corporation, income passes through directly to shareholders, without that income being taxed as corporate income. This means an S-Corporation is not responsible for corporate taxes, but rather is taxed like a partnership. A partnership tax return is filed for information purposes only, and income is reported on members’ personal tax returns.

In a C-Corporation, meanwhile, the business pays taxes on the business income and shareholders pay taxes on dividends. Income is reported on a corporate tax return and dividends are reported on the shareholders’ personal tax returns.

If your LLC is taxed as a corporation and members receive money from the business in the form of dividends, members should be issued 1099-DIV. This form is to report the dividend income received.

The LLC is expected to issue the 1099-DIVs to members and send copies to the IRS. Members also submit copies with their personal tax returns.

Issuing 1099s

You will also be responsible for issuing 1099s if you pay for services from independent contractors operating as sole proprietors or non-corporation LLCs (single-member LLCs and LLCs taxed as a partnership need 1099s). Corporations or LLCs taxed as corporations do not receive 1099s.

But how do you know their tax status? All independent contractors you hire must fill out a W-9 form, which is the “Request for Taxpayer Identification Number and Certification”.

There is a box on the form that the contractor has to check to specify their tax status. If they check the LLC box, they also have to check a box to indicate if they are taxed as an S Corp or C Corp. Unless they have indicated S Corp or C Corp status, you must issue that contractor a 1099.