LLC is a disregarded entity when it comes to taxing, which means no corporate taxes on business earnings. The profits and losses are carried forward to the member’s income tax. But that is not all. There is more to the picture.
Read along to know all the taxes an LLC and its members pay.
Does LLC Pay Taxes?
Yes, LLCs do pay taxes, but not over profits as corporations. It is liable to pay taxes like Medicare and social security taxes.
LLCs are separate legal entities from the owner/member yet it is considered a pass-through entity for taxation purposes. Which means limited personal liability and no corporate taxing. It is considered the best of both worlds. But not in every aspect. There are some taxes the LLC has to pay and the significantly higher setup cost and running cost of book keeping compared to partnership and sole-proprietorship.
LLCs also can opt to be taxed as corporations. While paying an additional 21% tax might not be charming at first, the corporate taxing structure has significant advantages for LLC in certain use cases.
What Taxes does an LLC Pay?
LLC being a legal entity of its own is subjected to taxes on employee benefits. Following or the most common and significant taxes LLCs pay.
Social security taxes
This is the most common tax in every country except for its name. It is the fund collected for the retirement benefits and more in some cases. The employee and the employer (LLC) contribute equal shares to it. The social security tax in the US is 12.4% which means 6.2% will be held from the salary and the rest 6.2% is contributed by the LLC towards the fund, deposited monthly.
Medicare taxes/Health Insurance
LLCs need to contribute a certain sum towards the healthcare of their employees. In some countries the fund is forwarded to external health insurances while in most developed nations it is handled by the government backed healthcare system like Medicare in the US. LLCs in the US have to pay a 2.9% Medicare tax of every employee, split equally between the employee and employer.
Unemployment taxes
This is a backup fund to support the unemployment during unforeseen conditions. Not common in many countries. In the US the employer pays 0.6% up to a total salary of $7000 per employee.
Sales tax
It is an inevitable tax, independent of the business structure. You remit the tax collected from the sale of goods and services to the tax department. The sales tax rates depend on the product/service you sell and the jurisdiction of sales & operation.
LLC Tax or fee
Some jurisdictions tend to levy a minimal fee on operating LLC businesses as a form of renewal charges etc. It can range from $100 to $800 per year in the United States. And is rare in most states/countries.
If you’re willing to go a step further you can form a company in a tax haven like UAE starting from just $600 to save hundreds and thousands in taxes.
What Taxes does an LLC Member Pay?
To be clear, “LLC member(s)” is the official term used to mention the owners of the business which is an LLC. An LLC can have a minimum of one member to as many your state/country jurisdiction allows to. The share of stake held by each LLC Member is mentioned in the formation deed or any buy/sell/transfer agreement made thereafter.
The profits and losses of the LLC are passed over to the LLC members directly until the LLC has opted to tax as corporation. Hence LLC members too are subjected to tax payments directly or indirectly. Following are the LLC Member taxes.
Personal Income Tax
The profit/loss of the LLC in any given financial year is passed on to income tax of LLC members. There it is taxed based on the income level and jurisdiction of residence. The profit/loss from the LLC is proportional to the LLC member’s stake in the business. Profit is taxed, losses deducted and the expenses of the business are also detectable in the personal income tax. But No profit can be retained with the business without taxing (one of the biggest drawbacks of LLC).
Self-Employment LLC Taxes
LLC members are not considered employees but are required to pay self-employment tax which in turn brings Social Security Tax and Medicare Tax into the picture. In the US, Self-employment tax is 15.9% (12.4 Social security tax + 2.9 Medicare + 0.9 Medicare surtax on earnings over $200,00)
Types of LLCs Vs Taxes
As we know what taxes LLCs are subjected to, let us get into which type of LLC pays what taxes and how.
To understand what taxes LLC has to pay, we shall approach one type at a time.
- Single Member LLC
- Multi Member LLC
- LLC taxed as a corporation
How is a Single Member LLC Taxed?
Single member LLC is officially treated as a disregarded entity in taxing terms. Disregarded entities do not require to file separate tax returns. All of the expense and revenue shall reflect in the owner’s income tax return. It is done through form 1040 schedule C in the US. The profits need to be taxed and reported without an option of profit retained within the company.
Though LLCs don’t employ its members, self-employment tax is necessary. Additionally, the self-employment tax needs to be assessed based on expected income and needs to be deposited quarterly. Failing to do so or paying less would attract fines and penalties.
The profits of business are taxed under personal income tax rates and losses, if any can be detected from the income. Besides if you have an employee, employment taxes (social security tax, Medicare tax, unemployment tax) are required to be collected and paid monthly.
It sounds very similar to Sole proprietorship, but not in every aspect.
Sole Proprietorship Vs Single-Member LLC
Sole proprietorship provides no protection on personal assets while Single-member LLC provides limited liability to its members. LLC takes more time and money to form than proprietorship.
Raising capital is considerably easy with LLC as it can add a member to the LLC without much procedures. On the other hand, bringing in a new owner will change the business structure all together for a sole proprietorship. So, opting for a small business loan is the only go in most cases.
What taxes does a Multi Member LLC need to pay?
Multi-member LLC is considered a partnership business structure for taxing purposes. The profit/loss is passed on to LLC members in proportion to the ownership stake held by them which is then filed in their personal income tax. The profits can be altered and distributed based on requirement but the taxation is to be followed based on profit allocation.
In Multi-member LLC additionally tax return form is required to be filed with the tax department and distributed officially to all the LLC members based on which the income and deductions are filed in their individual income tax return. Likely, all of the profits need to be reported and taxed even if a portion of the profit is expected to be utilized by the business in the next tax year.
Taxes of Single/Multi Member LLC opted for corporate taxation structure.
Opting out of pass-through taxation (one of the strong points of LLCs) might not seem the right thing to do for beginners. But the biggest issue with LLCs and informal business structures is inability to retain profits in the business for future expenses and expansions.
By opting for corporate tax structure, you can retain profits as capital without any limitation. But that comes with a corporate tax (usually, 21%) on the retained amount and double taxation on the profits pushed out to the LLC members.
Wondering how it is better and when, here you go.
When should an LLC opt to tax as a corporate?
LLCs opt to corporate tax mainly to save on retained profits and escape higher tax rates on high income.
- So, if you are a fast-growing company looking out for a fast growth phase and want to retain the most money within the company then consult a finance expert and see if corporations can save on taxes.
- Incomes staggering in personal income tax can cost 30-35% tax based on the jurisdiction you reside upon the self-employment taxes. Changing to corporate taxing will have lesser taxes.
Still confused about taxing and not sure if it is the best business structure?
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