Single and Multi-Member LLC Tax Structures
Single-Member LLCs are taxed by the IRS as “Disregarded Entities.”Disregarded entities sounds strange and confusing, but it just means the IRS ignores the structure of your business (i.e. the fact that it's a single-member LLC) and taxes you like it does any individual. The LLC’s income is reported on your personal tax return at the end of the year.
If the IRS treats my single-member LLC as a disregarded entity, do I still get the benefits of being an LLC? Even though the IRS ignores the LLC structure when it comes to taxation, don’t worry—you still get the benefits of personal asset protection and deduction of business expenses.
To ensure you get these benefits, you should conduct your business in a formal way. These basic rules are outlined in our article, Maintain Your LLC's Corporate Veil.
A Multi-Member LLC is typically taxed as a partnership by the IRS. This means that LLCs do not pay any income taxes to the IRS and all profits are passed through to the members of the LLC as per the partnership operating agreement. The members of the LLC then pay the taxes to the IRS on their individual tax returns.
Other LLC Tax Structures: S-Corp and C-Corp
For most people starting an LLC, the default tax structures—“disregarded entity” for single-member LLCs or “partnerships” for multi-member LLCs—are probably the most appropriate. These are the standard tax structures for LLCs, and do not require a special election when forming.
However, under certain circumstances, both single-member and multi-member LLCs can also elect to be taxed like a corporation. The two corporate tax classifications are C-Corp and S-Corp. Selecting these tax structures can be done when you apply for an EIN for your LLC or at a later time.
A C-Corporation (C-Corp) pays taxes on gross income minus all operating expenses. They then distribute profits to shareholders, and shareholders pay income tax on the dividends. This is also known as "double-taxation.”
An S-Corporation (S-Corp) is a tax classification with specific rules that can be beneficial to your company if your business earnings are significant. An S-Corp allows the member(s) of a company to save on taxes. However, before making a decision, it’s important to understand the basics of an S corp and what changes may be in store for your business if you choose this status.
Regardless of which tax designation you elect for your LLC, you still have to file with the IRS. All owners will have to fill out Form 1040—your individual income tax return—and its appropriate schedules:
- Schedule C--a form where you report income specifically from your business
- Schedule SE--a form where you file and pay your self-employment taxes.
- Schedule E--a form where you report income from rental properties and other investments.
Check out our Federal Taxes Guide to see a full list of the necessary forms and schedules for a single-member LLC.
Multi-member LLCs and special entities will need to file more than that. Partnerships, in addition to Form 1040, must also file the following:
Because LLCs are typically “pass-through” entities, they do not have to pay separate state taxes. That is, the individual members pay state taxes; not the LLC itself. Here are some of the common forms of state tax:
- Franchise Tax: Some states require this tax, which is based on how much an LLC earns per year.
- Sales and Use Tax: If you sell physical products, consumers pay this tax to you and you pay this tax to your respective state or local governments.
- Gross Receipts Tax: While similar to a sales tax, a gross receipts tax is paid by the seller rather than the buyer.
- Withholding Tax: This is income that is withheld from employee paychecks and paid to the government.
- Unemployment Insurance (UI) Tax: UI is used for unemployment benefits. Tax rates are set by state law.
You can find out more about state taxes in detail in our guide.
As a business, you are able to deduct certain expenses from your taxes. The IRS says that a deductible business expense is both “ordinary and necessary.” In other words, your business can write off any expenses that help your business succeed. This can include a variety of purchases; these are just a few common examples:
- Office supplies
- Rent and general maintenance
- Licenses and permits
Some expenses, such as travel and entertainment-related purchases, are harder to deduct. These categories have spending limits, additional terms, or must be capitalized.
Of course, expenses are only deductible if they are “appropriate.” You might think a rooftop Jacuzzi is important for maintaining your business, but the IRS probably won’t agree with you unless you’re a Jacuzzi-selling business.
You can see a complete list of basic and complex deductions.
Bookkeeping and Accounting
It’s important to make sure your books are in order to protect your corporate veil.
Separate your personal matters from your business expenses as much as possible. You can do this by:
- Opening a separate business bank account
- Obtaining a business credit card for work-related purchases
- Creating a solid bookkeeping system - A high-quality accounting program can help keep track of your expenses and make the process simple and relatively pain-free. You can also hire an accountant.
Check out our Guide to Small Business Bookkeeping to learn more.
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