Ah, taxes. No one can avoid them, including your LLC. So, once you’ve formed your LLC, you need to take taxes into consideration. 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. Keep in mind that, while we’ve made every effort to ensure this information is accurate and up-to-date, it doesn’t constitute legal advice, nor should it be used as a substitute for legal advice. It’s always best to consult your attorney for personalized guidance on all things related to your LLC, including taxes.
First Up, Federal Taxes
Federal taxes are those 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 to be concerned with: 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 to consider you, the owner, a sole proprietor. So if you had been working as a sole proprietor prior to establishing your LLC, you’ll already be quite familiar with the tax rules.
- When you’re taxed like a sole proprietor, you and your business are considered one and the same for tax purposes. Therefore, your LLC doesn’t pay taxes or file federal tax returns. Instead, you must 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 have accrued. This could include interest income or your spouse’s income if you’re married and filing a joint tax return, as a couple examples. The total amount earned is then taxed.
- Keep in mind that, even though you’re taxed on your total income, regardless of the sources of that money, the IRS still wants to know about the profitability of your LLC. So, in order 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 (on this form, you 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. These rates are somewhat lower than they used to be, thanks to the passage of the Tax Cuts and Jobs Act.
Here’s a chart that shows the 2018 income tax rates (bear in mind that tax rates and rules can change over time):
2018 Personal Income Tax Rates
|Rate||Married Filing Jointly||Individual Return|
|10%||$0 – $19,050||$0 – $9,525|
|12%||$19,050- $77,400||$9,525 – $38,700|
|22%||$77,400 – $165,000||$38,700 – $82,500|
|24%||$165,000 – $315,000||$82,500 – $157,500|
|32%||$315,000 – $400,000||$157,500 – $200,000|
|35%||$400,000 – $600,000||$200,000 – $500,000|
|37%||over $600,000||over $500,000|
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, home or outside office, and more. That’s great news!
In addition to regular business deductions, you may be able to take the new pass-through tax deduction that went into effect in 2018 as well. If you qualify, you might be able to deduct from your income taxes up to 20% of the net income you earn from your LLC. This will effectively reduce 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 be paying tax on your LLC income at just 17.6%. Everyone loves a good tax break!
And 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 have to 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 either. All of this could help you save hundreds of dollars every year. Sweet!
But, wait. 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 (FICA tax) paid for an employee. They consist of a 12.4% Social Security tax on income up to an annual ceiling (in 2018, the annual Social Security ceiling was $128,400). Medicare taxes consist of a 2.9% 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 taxed at a 3.8% rate.
This combines for a total 15.3% tax on employment or self-employment income up to the Social Security tax ceiling, which is adjusted annually for inflation.
What about paying estimated taxes?
As someone who is self-employed and taxed like a sole proprietor, no tax will be withheld from your pay. Therefore, you are 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.
You’ll be hit with a penalty if you estimate wrong and end up paying too little. However, you will 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, and 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 will need to approach your taxes a bit differently.
First off, there are two types of corporations when it comes to taxes: the C corporation is also called a regular corporation, while the S corporation is 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. And, even though this isn’t commonly done by freelancers with single member LLCs, it might become increasingly more common because the corporate tax rate is much lower now than it used to be.
Also, 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 have to pay employee payroll taxes, as well as withhold income and Social Security and Medicare taxes from your pay and send those off to the IRS. It will also have to file employment tax returns, and likely provide you with California unemployment insurance coverage.
- Beyond that, your LLC must pay you reasonable employee compensation, and you must pay tax on your salary, bonuses, and other taxable payments from your LLC (at your individual tax rates).
- Finally, the LLC can deduct employee salaries and benefits from its taxable income, so there’s no double taxation on those payments, but there are no tax savings either. A lot to consider!
The Basics of C Corporation Taxation
- C corporation taxation is the default mode of taxation for LLCs that choose to be taxed as corporations.
- A C corporation is considered a separate entity from its owners for income tax purposes. Therefore, profits and losses don’t pass through to the owners’ individual tax returns.
- C corporations must pay income taxes on their net income, as well as file their own tax returns with the IRS using Form 1120.
- If your LLC is taxed like a C corporation, it pays income tax only on its net profit for the tax year. 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 form the pass-through tax deduction established by the Tax Cuts and Jobs Act (discussed above).
- You don’t pay tax on the LLC’s earnings unless you actually receive the 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 corporation tax rate to a single flat tax of 21%. This is lower than individual rates at certain income levels. However, this doesn’t necessarily mean you’ll save any tax with C corporation taxation, as you have to deal with double taxation.
C Corporation Income Tax Rate—2018 and Later
|Taxable Income||Tax Rate|
|All over $0||21%|
- Any direct payment of your LLC’s profits to you will be considered a dividend by the IRS and taxed twice. First, the LLC will pay corporate income tax on the profit at the 21% corporate rate on its own corporate return. Then, you’ll pay personal income tax on what you receive from the LLC at capital gains rates, which can be as high as 20% (higher income taxpayers must also pay an additional 3.8% Medicare tax).
- When you add the personal tax on dividends to the 21% C corporation income tax, the combined tax is often higher than the income tax that a single member LLC owner who’s taxed as a sole proprietor would pay on a similar income. Just something to think about as you decide how you’d like your LLC to be taxed.
The Basics of S Corporation Taxation
- An S corporation pays no tax itself. Income and losses pass through the corporation to the owners’ personal tax returns to be taxed at their individual rates.
- Your LLC files an S corporation 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 income on your return. If you’re a single member LLC, your share should be 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 corporation taxation can help business owners save on Social Security and Medicare taxes. You don’t have these on distributions (dividends) from your LLC—that is, on earnings and profits that pass through the LLC to you as the owner.
Next Up, California Taxes
The state of California imposes its own taxes on businesses and LLCs. And you might be surprised to learn that it has some of the highest state taxes in the nation. Now that’s rough!
If your LLC is taxed as a sole proprietorship:
- You must pay an $800 LLC tax annually, even if your LLC doesn’t earn any money.
- You must pay an annual LLC fee, which depends on your LLC’s gross income. Here’s a chart that can help:
|If Total LLC Income Is:||If Total LLC Income Is:|
|$250,000 to $499,999||$900|
|$500,000 to $999,999||$2,500|
|$1,000,000 to $4,999,999||$6,000|
|$5 million or more||$11,790|
- You must pay California income tax on your net LLC income (rates range from 1% to 13.3%).
If your LLC is taxed as a corporation:
- Your LLC will have to pay a minimum $800 franchise tax fee every year, except the first year it’s in operation.
- Your LLC will have to pay California corporation taxes. If taxed like a C corporation, pay a flat 8.84% tax on net income. If taxed like an S corporation, pay a 1.5% tax on net income.
- California is one of the few states that impose taxes on S corporation income. When your LLC is taxed like an S corporation, 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 can be complicated and confusing, especially when you’re dealing with business taxes. If you need valuable guidance when it comes to paying the right taxes, as well as taking advantage of tax benefits that come with running your LLC we’re happy to help you navigate your LLC taxes and simplify the process. Feel free to send a us a message.
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.