Ah, taxes. No one can avoid them, including your LLC. So, once you’ve formed your LLC, you need to seriously start thinking about taxes.
The problem is that, when it comes to business taxes, things could get complicated. But the good news is that, with LLC taxes, you have several options. Here’s some information that might be helpful when it comes to understanding what to expect with LLCs and taxes.
Federal taxes are imposed by the IRS.
Everyone in the United States has to pay these taxes, and they’re much higher than the taxes imposed by California or other states.
There are two main federal taxes for LLCs: income taxes and Social Security and Medicare taxes.
LLCs Taxed as Sole Proprietorships
If you’re operating your business as a single-member LLC, the default federal tax treatment is sole proprietorship.
If you’ve been working as a sole proprietor prior to establishing your LLC, you’ll already be familiar with these tax rules.
When you’re taxed like a sole proprietor, you and your business are considered one and the same for tax purposes.
The good news is that your LLC doesn’t pay taxes or file federal tax returns. Instead, you report the income you earn or the losses you incur from your LLC on your personal tax return (IRS Form 1040).
If you earn a profit from your LLC, that money is added to any other income that you’ve earned. This includes interest income or your spouse’s income if you’re married and filing jointly. The total amount earned is then taxed.
Although you’re taxed on your total income, the IRS still wants to know about the profitability of your LLC.
To show whether you have a profit or loss from your LLC, you must file IRS Schedule C, Profit or Loss from Business with your tax return. Here, you’ll list all of your business income and deductible expenses.
What are the tax rates when you’re being taxed like a sole proprietor?
You’ll pay tax on your net LLC income at your personal income tax rates.
Here’s a chart that shows the 2019 income tax rates (bear in mind that tax rates and rules can change over time):
2019 Income Tax Brackets
What about tax deductions when you’re taxed like a sole proprietor?
You’re entitled to the same tax deductions as any other business. This includes expenses like equipment, mileage, travel, rent, office supplies, software, and more.
In addition to regular business deductions, you may be able to take the pass-through tax deduction that went into effect in 2018 as well. If you qualify, you might be able to deduct up to 20% of the net income you earn from your LLC from your income taxes. This effectively reduces your income tax rate on your LLC profits by up to 20%.
Let’s say that your top tax rate is 22% and you qualify for the 20% pass-through deduction. In this case, you’ll pay tax on your LLC income at just 17.6%. Everyone loves a good tax break!
What about self-employment taxes?
Because your LLC is taxed as a sole proprietorship, you aren’t considered an employee of your LLC. Instead, you’re a business owner—a.k.a. self-employed. You’re living the dream of being your own boss!
In this case, your LLC doesn’t pay payroll taxes on your income or withhold income tax from your pay. It also doesn’t need to file employment tax returns or pay state or federal unemployment taxes. And you don’t need to be covered by workers’ compensation insurance. All of this saves you hundreds of dollars every year.
But you do have to pay self-employment taxes—that is, Social Security and Medicare taxes—on your business income (called self-employment income by the IRS). Self-employment taxes are equivalent to the total Social Security and Medicare tax paid for an employee.
They consist of:
- 12.4% Social Security tax on income up to an annual ceiling (in 2019, the Social Security income ceiling was $132,900)
- 2.9% Medicare tax up to an annual ceiling of $200,000 for single taxpayers and $250,000 for married taxpayers filing jointly. All income above the ceiling is subject to Additional Medicare tax of 0.9%.
The combined total for both of these taxes is 15.3% tax on employment or self-employment income.
What about paying estimated taxes?
As someone who’ is taxed like a sole proprietor, no tax is withheld from your pay. This means you’re required to prepay your taxes in advance throughout the year.
These tax payments are known as estimated taxes. As the name implies, you have to estimate how much money you’ll make during the year, and pay enough to cover the income and self-employment tax you’ll owe.
If you estimate wrong and pay too little you’ll be hit with a penalty. However, you can avoid the penalty if you pay at least as much as you paid the prior year (110% as much if you earned more than $150,000).
Estimated taxes must be paid to the IRS four times a year:
- April 15
- June 15
- September 15
- January 15
So be sure to mark your calendar!
LLCs Taxed as Corporations
What if you decide that your LLC will be taxed as a corporation instead? Well, you’ll approach your taxes a bit differently.
There are two types of corporations when it comes to taxes:
- C Corp (also called a regular corporation)
- S Corp (also known as a small business corporation)
There are big differences between these types of corporate taxation, and you can elect to have your LLC taxed either way.
Side note: To be taxed like a corporation, you need to file a document called an election with the IRS. You can do this at any time.
When you opt to have your LLC taxed as a corporation, you must become your LLC’s employee if you actively work in the business.
What does this mean for you?
- Your LLC will pay employee payroll taxes and withhold income, Social Security, and Medicare tax from your pay. It will send those tax withholdings to the IRS and file employment tax returns. Also, it’s likely that your business will have to provide you with California unemployment insurance coverage.
- Your LLC must pay you reasonable employee compensation, and you’ll pay tax on your salary, bonuses, and other taxable payments from your LLC (at your individual tax rates).
- Your LLC can deduct your employee salary and benefits from its taxable income. That means there’s no double taxation on those payments, but there’s also no tax savings either.
The Basics of C Corp Taxation
C Corp taxation is the default mode of taxation for LLCs that choose to be taxed as corporations.
A C Corp is considered a separate entity from its owners for income tax purposes.
That means profits and losses don’t pass through to the owners’ individual tax returns. Instead, C Corp pay income taxes on their net income and file their own tax returns with the IRS using Form 1120.
If your LLC is taxed like a C Corp, it pays income tax on its net profit for the tax year and it pays this at the corporate tax rate.
Your LLC gets to deduct all of its business expenses from its income. This includes employee salaries, most fringe benefits, bonuses, and operating expenses like office rent. An LLC taxed like a corporation doesn’t benefit from the pass-through deduction.
You don’t pay tax on the LLC’s earnings unless you actually receive money as compensation for your services (salaries and bonuses) or as dividends. The LLC itself pays taxes on all profits left in the business.
The Tax Cuts and Jobs Act dramatically reduced the C Corp tax rate to a single flat tax of 21%.
This is lower than individual rates at certain income levels. However, it doesn’t necessarily mean you’ll save any tax with C Corp taxation since you have to deal with double taxation.
C Corp Income Tax Rate—2018 and Later
|Taxable Income||Tax Rate|
|All over $0||21%|
Any direct payment of your LLC’s profits to you are considered a dividend and taxed twice.
First, the LLC pays corporate income tax on the profit at the 21% corporate rate on its own corporate return. Then, you pay personal income tax on your dividends at capital gains rates, which can be as high as 20% (higher-income taxpayers must also pay an additional Medicare tax).
When you add the personal tax on dividends to the 21% corporate tax rate, the combined tax is often higher than the income tax an LLC owner taxed as a sole proprietor would pay.
The Basics of S Corp Taxation
An S Corp doesn’t pay taxes itself.
Income and losses pass through the corporation to the owners’ personal tax returns and are taxed at the owner’s individual rates.
Your LLC files an S Corp information return (Form 1120S) with the IRS, reporting its income and deductions. You file Schedule E with your personal tax return (Form 1040), showing your share of the LLC’s income, which you add to your other personal income. If you’re a single-member LLC, your share is 100%.
Your LLC profits are taxed at your individual income tax rates—just like when your LLC is taxed like a sole proprietorship. No double taxation and you can qualify for the pass-through deduction.
S Corp taxation can help business owners save on Social Security and Medicare taxes. You don’t pay Social Security and Medicare taxes on distributions from your LLC—that is, on earnings and profits that pass through the LLC to you as the owner.
The state of California imposes its own taxes on businesses and LLCs. You might be surprised to learn that it has some of the highest state taxes in the nation. It’s rough!
If your LLC is taxed as a sole proprietorship:
- You pay an $800 LLC tax annually, even if your LLC doesn’t earn any money.
- You pay an annual LLC fee, which depends on your LLC’s gross income.
- You pay California income tax on your net LLC income (rates range from 1% to 13.3%).
Here’s a chart that can help:
If your LLC is taxed as a corporation:
- Your LLC pays a minimum $800 franchise tax fee every year, except the first year it’s in operation.
- Your LLC pays California corporation taxes. If taxed like a C Corp, you pay a flat 8.84% tax on net income. If taxed like an S Corp, pay a 1.5% tax on net income.
California is one of the few states that impose taxes on S Corp income.
When your LLC is taxed like an S Corp, its net income is passed through and taxed on your individual tax return at your individual tax rates. This means you’ll have to pay the 1.5% tax on top of your individual federal and state income tax on your LLC’s income.
Simplify Your LLC Federal and State Taxes
There’s no denying that taxes are complicated and confusing, especially when you’re dealing with business taxes.
If you need guidance when it comes to paying the right taxes, and how to take advantage of tax benefits that come with running your LLC, contact Collective. We’re happy to help you navigate your LLC taxes and simplify the process. Feel free to send us a message anytime!
Stephen has dedicated his career as an attorney and author to writing useful, authoritative and recognized guides on taxes and business law for small businesses, entrepreneurs, independent contractors, and freelancers. He is the author of over 20 books and hundreds of articles and has been quoted in The New York Times, Wall Street Journal, Chicago Tribune, and many other publications. Among his books are Deduct It! Lower Your Small Business Taxes, Working with Independent Contractors, and Working for Yourself: Law and Taxes for Independent Contractors, Freelancers & Consultants.