LLC Taxation

To review, a limited liability company (LLC) is a form of business organization created by state law, designed to make life a little easier on business owners. It remains one of the most popular forms of business in the country.

But because LLCs were created by state legislatures, the IRS doesn't have a specific tax classification for an LLC...there is no "LLC" tax classification.

Accordingly, the IRS will classify an LLC as one of three existing tax classifications:

LLC Tax Classifications:

disregarded entity - If the LLC has only one owner (aka member), it will automatically be classified as "disregarded entity". In other words, an LLC owned by one person will be disregarded for federal tax purposes. The single owner of the LLC will simply report the LLC's profits or losses on his or her personal federal tax return (typically on Schedule C of his/her IRS Form 1040).
partnership - An LLC owned by more than one owner will automatically be taxed like a partnership. A partnership is a "pass through" classification meaning the LLC will not pay federal taxes on its profits, but rather its owners will report their pro rata portion of the profits on their tax returns. Although an LLC taxed as a partnership does not pay federal taxes, it does have to file an annual federal tax return (IRS Form 1065).
corporation (s-corp or c-corp) - An LLC has the option to be taxed like a corporation. The corporate taxation option requires the filing of a tax election. You can read more about the C-Corp and S-Corp options below.

If an LLC files an S-Corp Election (IRS Form 2553), it will be taxed federally under subchapter S of the IRS Code. Historically, this option was only available to corporations and for some reason we still refer to any entity taxed under Subchapter S as an "S-Corporation" even though it is entirely proper for an LLC to be taxed under Subchapter S.

An S-Corporation is a pass-through entity just like a partnership. In other words, an LLC taxed like an S-Corp does not pay federal taxes. Instead, all of the LLC’s profits "pass through" the LLC and the LLC's owners pay federal income taxes on their share of the profits (regardless of whether they actually received a distribution from the LLC).

What are the benefits of S-Corp Taxation?

An LLC taxed like an S-Corp has two main benefits:

The LLC can pay its owners a salary;
The LLC owners who are also employees can potentially reduce their self-employment tax obligations.

Don't forget to read our LLC vs S-Corp article if you haven't already.

Self-Employment Taxes Explained:

The owners of a standard/typical LLC (partnership or disregarded entity taxation) will pay income taxes AND self-employement taxes on their pro rata share of the LLC's profits. In other words, if the LLC has two equal owners and profits of $100,000, each owner will pay income taxes at their respective tax bracket rate AND self employment taxes (15.3%) on their 50% of the profits.

Unlike a traditional LLC, an LLC taxed like an S-Corp can pay its owners a salary. An owner of an LLC S-Corp who is also an employee pays self-employment taxes on their salary rather than their pro-rata share of the profits.

Can My LLC Elect to Be Taxed Like an S-Corp?

In most cases, yes. However, Subchapter S was created with small businesses in mind. By extension, the IRS will only allow your LLC to make an S-corp election if:

The LLC has less than 100 members/owners, and
Each of the LLC’s members is an individual, and
Every member is a legal resident or citizen of the United States.

A C-Corp is what people usually think of as a "regular" corporation. Picture any of the major corporate giants in this country — the big Fortune 500 companies — and you’ll have a good sense of what a C-Corp is.

If an LLC makes a C-Corp election with the IRS (by filing IRS Form 8832), it will be taxed just like a corporation. In other words, the LLC will file an annual corporate tax return and pay corporate taxes on the LLC's profits (and the LLC's owners will pay income taxes on the distributions they receive from the LLC).

Does a Corporate Tax Election Turn an LLC into a Corporation?

No. The S-Corp and C-Corp elections are only relevant to federal tax returns with the IRS. For every other purpose, your business will remain an LLC (generally a less burdensome form of business than a corporation).

If the LLC better than a Corporation? Learn about the advantages and disadvantages of each in our LLC vs Corporation article.

SEE DETAILED PRICINGPACKAGES STARTING AT $99

Please note that tax issues are complex. We are not tax specialists. As such, we must recommend that you consult a tax professional if you have specific questions or special circumstances. According to IRS Circular 230 to ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this writing was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matters addressed herein.

Get Started Today