Limited liability companies, or LLCs, are a popular and flexible form of small business entity. In addition to low regulation and management requirements, LLCs offer business owners a variety of taxation options.
By default, LLCs are "disregarded entities" for tax purposes. This means they pay no corporate taxes, and all income passes to the owner's tax returns. However, by filing the right IRS forms, LLC owners can easily switch to a different type of taxation.
Single Member LLCs
A single member LLC has only one owner and no partners, and is taxed like a sole proprietorship. The owner reports all of the LLC's income on IRS Form 1040 Schedule C. Schedule C is the worksheet that allows self-employed individuals to report their total business revenue, as well as their expenses and mileage. The worksheet deducts business expenses from business revenues to arrive at net profit, which is subject to self-employment tax as well as ordinary income tax. Therefore, single member LLCs must file form SE to report their self-employment tax liability. All income taxes are paid on the LLC owner's 1040 tax return.
LLCs Taxed as Partnerships
LLCs with multiple members are taxed as partnerships by default. As such, the LLC must file a Form 1065 partnership income tax return. Form 1065 reports the LLC's revenue for the year, and calculates its net profit after business expenses. The partners split the profits according to the LLC's operating agreement, which spells out what percentage of profit each partner receives. The LLC then gives each partner a K-1 statement, which reports the net profit that individual received from the LLC in that year. Partners use K-1 forms to report this income to the IRS, just as employees use W-2s.
LLCs Taxed as a Corporation
LLCs may elect to be taxed as corporations. This election is available both to single member LLCs and to LLCs comprising multiple members. In order to change the default taxation of an LLC to that of a corporation, the LLC must execute and submit IRS Form 8832, which requires each member of the LLC to approve the change.
Form 2253 allows corporations—or LLCs that are taxed as corporations—to elect S corporation taxation. This is a blend of partnership taxation and corporate taxation.
Corporations file their annual tax returns with Form 1120, while S corporations use Form 1120s.
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