A limited liability company, or LLC, is a business entity type that has a history in the United States that spans decades rather than centuries. The relative newness of the format means that the Internal Revenue Service has yet to recognize the LLC as a specific tax entity type. Instead, the IRS classifies an LLC as one of the existing entity types that are defined in the tax code, based on the number of owners, known as members, and the tax elections those owners make. Single-member LLCs can elect to be taxed as a sole proprietorship or a corporation. Multiple-member LLCs can elect to be taxed as a partnership or a corporation. The way a LLC claims profits and losses depends on this tax election.
LLCs Taxed as Sole Proprietorships
Create a year-end report of business revenue and expenses. Since a sole proprietor's operating period is a calendar year, this report should be prepared in the weeks immediately following December 31.
Record revenue and expenses on IRS Form 1040, Schedule C, Profit or Loss from Business, on the LLC member's individual federal income tax return. Some types of revenue and expenses should be recorded on Schedule E for supplemental profits or losses or Schedule F for farming profits or losses.
Claim Schedules C, E or F profits and losses under the rules for individual tax obligations. Any resulting business profit that is indicated on Schedules C, E or F is taxed at the member's individual tax rate. Any resulting business loss is deducted from the member's income from other sources, resulting in a lower tax assessment on that income.
LLCs Taxed as Partnerships
Create a year-end report of business revenue and expenses. Also, tally the capital accounts for all members, including loans, equity contributions and capital distributions. LLCs with multiple members must have an accurate year-end record of each member's ownership interest percentage as of December 31, so each member can be allocated his share of profits and losses.
Prepare IRS Form 1065, U.S. Return of Partnership Income, for the LLC. This is an information return for the business, not a regular tax return. An LLC that is taxed as a partnership passes its profits and losses through to its members. This return simply notifies the IRS of the amounts that will be passed through to members to ensure that taxes are paid. Part of Form 1065 is Schedule K-1, which is a record of how profits and losses should be allocated to each member.
Send each member a copy of Schedule K-1. The member will use Schedule K-1 to transfer his portion of business profits and losses to his personal income tax return; the amounts will be taxed at the individual rate.
LLCs Taxed as Corporations
Generate the LLC's fiscal year-end financial reports. An LLC that is taxed as a corporation can select a fiscal year that ends in any month; it must file its return by the 15th day of the 3rd month after the end of its tax year.
Prepare IRS Form 1120, U.S. Corporation Income Tax Return. An LLC that elects to be taxed as a corporation is taxed as a C corporation and pays taxes in it's own name unless it elects to be taxed as an S corporation. Profits and losses for a C corp are recorded on Form 1120; the business pays taxes at the corporate income tax rate.
Prepare IRS Form 1120-S, U.S. Income Tax Return for an S Corporation if the LLCs that has elected to be taxed as an S corporation. S corporations are disregarded entities like partnerships. This form functions just like a partnership return, informing the IRS of profits and losses, but generating a Schedule K-1 so the amounts can be claimed on the members' individual tax returns.
- Internal Revenue Service: Sole Proprietorships
- FindLaw: How LLCs Are Taxed
- Internal Revenue Service: Forms for Limited Liability Companies (LLC)
- Niesar & Vestal LLP: Legal Resources -- Essential LLC Accounting Concepts
- Citizen Media Law Project: Limited Liability Company
- Internal Revenue Service: Publication 3402 – Taxation of Limited Liability Companies