If you own a limited liability company (LLC), your business is a separate entity, much like a partnership or sole proprietorship. Your company is not treated as a separate entity unless it files as a corporation. The IRS taxes C corporations directly, but your limited liability company isn't taxed directly if it elects to file as a pass-through entity.
Filing as a Corporation
Owners of an LLC can elect how the IRS should treat it for tax purposes. They can file as a C corporation, an S corporation, or be treated as a pass-through entity, which is most common for LLCs. In this instance, the individual owners claim income from the company.
The profits and losses pass through to the individual owners, who include them as income on their personal tax forms. If the company is a multiple-member entity, the owners must file the Partner's Share of Income, Deductions, Credits, etc. (Form 1065, Schedule K-1) with the IRS each year, which they use to gather information only; the form isn't used for payment purposes.
Filing as a Pass-Through Entity
Filing in this manner disregards your LLC as an entity, which means the business is not subject to income fees. For a sole proprietorship, the owner claims the full amount of the company's profits and losses on their individual return, and the IRS taxes the owner at the rate for their income bracket. If you're a sole proprietor, you would add a Profit or Loss From Business (Sole Proprietorship) (Form 1040, Schedule C) to your documentation to report the LLC income.
If your business operates as a partnership, the taxes are split among the partners. It's up to them to decide whether to receive their profits at the same percentage as their investment in the company. It is then split up according to the percentage of profits that each member takes, as stated in the Schedule K-1, and the partners report their profits using a Supplemental Income and Loss (Form 1040, Schedule E). Pass-through treatment usually ends up giving the members a better rate than if the IRS treated it as a corporation, although this depends on the income bracket the owner is in.
Filing as a C or S Corporation
A limited liability company can choose to file as a C corporation. If this happens, the business is subject to double taxation—the profits and again on for any dividends. However, the government imposes a lower rate on a C corp. if it decides not to offer dividends to its shareholders. Additionally, there are some benefits to filing in this manner, such as keeping the business profits separate from your other income and allowing certain business deductions. These benefits aren't often available if the company elects to operate as a pass-through entity.
An LLC filing as an S corporation can also get the benefit of this type of taxation if it qualifies. To qualify, the company must have only one class of stock and no more than 100 stockholders, none of whom are a corporation or partnership. S corporations are treated as pass-through entities. Some of the benefits for an LLC to file in this manner include savings on Medicare and Social Security taxes and having the owner compensated as both an owner and employee of the company.
An LLC's members can decide how they want the IRS to treat the company for tax purposes. Each of the three choices has certain advantages and disadvantages, so it's important to speak with the other members of your business to determine what's best for your company.
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