Here’s What You Need To Know

Small-business owners have a lot to consider when setting up shop, but one of the most important factors to think about is how your business will be taxed — and the business structure you choose will have a large impact.

If you choose to set up your business as a limited liability company, or LLC, the way you’ll be taxed will depend on whether it’s a single-member LLC or a multi-member LLC.

How to file taxes for an LLC

LLCs are treated as pass-through entities, which means the federal income taxes “pass through” to the owners. The LLC itself isn’t subject to taxes on business income. Instead, the owners pay the taxes on the company’s profits on their individual tax returns.

When you file taxes as an LLC, there is a default tax status as well as ones you can elect. The default status is either a sole proprietorship or a partnership (more on each below) — the default depends on how many people own the LLC.

It’s important to decide whether the default status is the most beneficial for your business. Some small-business owners opt to be taxed as a corporation instead.

“A lot of times when people get started, they go with those defaults because they’re overwhelmed by all the other things they have to do,” says Carl Breedlove, a leading Block Advisors small-business expert from The Tax Institute at H&R Block. But it’s important to think carefully about which taxation treatment makes sense for you (and bring in professional tax help if necessary).

You can decide to change your classification in any tax year; you’re not stuck with whatever decision you make the first time you file taxes for your business.

“As the business changes and evolves, you can make a change to best fit what suits your returns,” Breedlove says.

Single-member LLCs vs. multi-member LLCs

As the names imply, a single-member LLC is one in which there is only one owner, while a multi-member LLC is one in which there are several members who each have an ownership stake.

How single-member LLCs are taxed

If you’re a single-member LLC and you don’t make any elections, your default tax classification is a “disregarded entity,” which for all intents and purposes is a sole proprietorship. You would report all business income and expenses on a Schedule C come tax time. Any taxes owed on your net profit would be determined based on your personal income tax rate.

How multi-member LLCs are taxed

If you’re a multi-member LLC, then the default designation is as a partnership. You would file a Form 1065, U.S. Return of Partnership Income, and each partner would get a Schedule K-1 to report on their individual returns. States have forms similar to the Form 1065 and Schedule K-1 that apply for state taxes.

Corporate LLC vs non-corporate LLC status

With an LLC, instead of relying on the default status that applies to you (sole proprietor or partnership), you can choose to be taxed as a corporation.

• You can choose the C corporation filing status by filing Form 8832. You’d then pay a flat 21 percent tax rate. The biggest difference between this status and the LLC is that C corporations don’t have the same “pass-through” treatment that LLCs have. They pay taxes at the entity level, and any payments that flow through to you would be treated as dividends to the extent that they represent a business profit. You would pay taxes on those dividends. That’s how you might face double taxation, Breedlove says. “The entity pays tax and then you pay tax when you take the payments out, and that’s usually what steers people away from C corp. status.”
• You can choose the S corporation tax status by filing Form 2553. An S corp. is taxed as a pass-through entity. That could make it a better option for some small-business owners.

When a corporate LLC tax status makes sense

Whether you should choose to be taxed as a corporation or not will come down to your specific business. Seeking a tax professional for advice could be a good plan.

“There is no one-size-fits-all option,” Breedlove says. “You need to look at all the facts and circumstances that are particular to your business.”

When LLCs have to pay payroll taxes

Employers — such as those that hire W-2 workers — are responsible for withholding certain taxes from their employees’ paychecks and paying the employer share of those taxes. Similarly, LLCs that have employees have additional tax responsibilities. If you have employees (not just members) of your LLC, you’re responsible for collecting payroll taxes. You’ll have federal and state-level payroll taxes.

Usually, you’ll owe federal income tax and FICA taxes, which represent Social Security and Medicare. FICA is a set percentage — the employee pays half and the employer pays half. Then there’s the Federal Unemployment Tax Act (FUTA) tax, which is a fixed percentage. The income tax is the one that varies the most and is the one for which employees fill out a Form W-4 to determine how much is withheld, Breedlove says.

On the state level, generally there are similar taxes: a state-level income tax and state-level unemployment taxes. Depending on where you are, there may be additional local taxes, such as for your specific city.

“Every time that employee gets paid, all of those taxes get held and, depending on the size of the business and how they elect to do this, they would make deposits of taxes to the authority that needs them,” Breedlove says. “That could be biweekly, monthly or quarterly,” he says, depending on the size of the business.

The business would also have a payroll tax return they need to file, which most businesses do so quarterly, he adds. If you’re a small enough business, you could do so annually.

Do LLCs pay self-employment tax?

Members of an LLC are considered self-employed by the IRS and therefore must pay self-employment tax. They owe the aforementioned FICA taxes directly to the IRS (since those taxes aren’t taken out of a paycheck).

LLC members can use Schedule SE to figure out their self-employment tax and file it with their Form 1040.