Taxes and LLCs

Regular readers of my blog posts know I’ve addressed LLCs and taxes before. Questions about how to file taxes for an LLC still come up all the time, including last week at my Start-Up with Financial Success workshop at BizLaunch/Arlington Economic Development. So I decided to pull up a blog from “the Archives” and update it to share again.

Piece of paper that says "TAX" with hand holding pen

The first question I ask new tax clients who own a business is, “What type of business do you have?” The response I often get is “I have an LLC.” That answer isn’t enough information for me to know how and when to file their business taxes. I need to ask more questions at that point, like “and how do you operate for tax purposes?” Answering that one can be tough. 

An LLC is a state-defined limited liability legal business structure. Business owners often form an LLC to protect their personal assets in case their business is sued. An LLC can file business income taxes in one of three different ways, depending on the circumstances:

  1. Sole Proprietorship

Individual business owners that have not incorporated are, by default, a Sole Proprietor. Sole Proprietors report income and expenses on a separate form filed with the owner’s individual income tax return, IRS Schedule C, “Profit or Loss from Business.” A separate Schedule C must be filed for each business that the owner operates. Net business profits are subject to income tax and the employer and employee portions of Medicare and Social Security taxes (i.e., 15.3% in 2019).

  1. Partnership

Two or more individuals in business together without incorporating are, by default, a Partnership. Partnerships are considered a separate tax entity and are required to file a separate income tax return, IRS Form 1065, “U.S. Return of Partnership Income.” Partners receive an IRS Form K-1 for each one’s pro-rata share of non-wage income and expenses, based on the operating agreement (a MUST). Partners are responsible for tracking the basis of their shares to determine how distributions are taxed.

  1. Subchapter S Corporation

Qualifying businesses can take the Subchapter-S election and avoid the double taxation of a C Corp. A number of rules apply to see if a business owner(s) qualifies. Sub-S Corps are also considered a separate tax entity and are required to file a separate income tax return, IRS Form 1120S, “U.S. Income Tax Return for an S corporation.” Shareholders receive an IRS Form K-1 for their share of non-wage income and expenses, based on the operating agreement (again, a MUST). Owner/employees earn wages and get a W-2.

Determining how your LLC operates for tax purposes is not easy. It depends on the circumstances and many rules apply. Need more information? The IRS has you covered, as usual. Check out their tax information, tools and resources for business and self-employed individuals at https://www.irs.gov/businesses.