The default federal tax status for a single-member limited liability company (SMLLC) is to be a so-called disregarded entity. As a disregarded entity, the company itself doesn't pay income tax. Rather, the SMLLC owner is taxed like a sole proprietor: The SMLLC's net income (or loss) passes through the LLC to the owner's personal tax return and the owner pays tax on any profit at his or her personal tax rates. This is called pass-through taxation. However, you have a choice about how your SMLLC is classified with, and taxed by, the IRS. Instead of the default pass-through taxation status, you can elect to have your SMLLC taxed as one of two types of corporation:
This article briefly reviews the C corporation tax classification. There's a separate article in the SMLLC section of this website if you're interested in S corporation classification.
You can file an election for corporation tax status at any time after setting up your SMLLC. However, there are limitations on when the election can take effect. Specifically, your corporation tax status must become effective within the 75-day period before the filing date or within 12 months after the filing date. To make the election, complete and file IRS Form 8832, Entity Classification Election. The form is fairly simple and mainly involves checking off a few boxes. (In fact, this way of choosing a business's tax status is officially known as “check-the-box.”)
Your tax situation will be significantly different if you elect to have your SMLLC taxed as a traditional corporation instead of as a disregarded entity. For example, unlike a disregarded entity:
Here's a quick look at each of these points.
A corporation is considered a separate entity from its owners (shareholders) and employees, and is not disregarded by the IRS. As a separate entity, a corporation must pay separate taxes each year on its net income. Those taxes are different from taxes you'd pay on your own personal income: Corporations have their own income tax rate and their own income tax forms. The Tax Cuts and Jobs Act dramatically reduced the C corporation tax rate to a single flat tax of 21%. This replaced tax rates ranging from 15% to 35% that corporations paid before 2018.
C Corporation Income Tax Rate—2018 and Later
All over $0
The 21% rate is lower than individual rates at certain income levels. However, this doesn't necessarily mean a SMLLC owner will save any tax with C corporation taxation. This is because of double taxation. With C corporation taxation, any direct payment of an LLC's profits to the owner will be considered a dividend by the IRS. A dividend is not a deductible business expense by an SMLLC taxed as a corporation. As a result, it is taxed twice—a phenomenon called “double taxation.” First, the LLC will pay corporate income tax on the profit at the 21% corporate rate on its own corporate return, and then the SMLLC owner will pay personal income tax on what he or she receives 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 the personal tax on dividends is added to the 21% C corporation income tax, the combined tax is often higher than the income tax a SMLLC owner taxed as a sole proprietor would pay at his or her individual rate on a like amount of income. This can be particularly true if the SMLLC owner would qualify for the pass-through deduction that went into effect in 2018. SMLLC owners who qualify can deduct up to 20% of their net business income from their income taxes with this deduction, effectively reducing their individual tax rate on their SMLLC income by 20%. The pass-through deduction is not available to SMLLCs that are taxed as C corporations.
However, double taxation can be avoided by the SMLLC paying the owner salaries and bonus instead of dividends as described below.
If your SMLLC is classified as a corporation, then, in contrast to owning an SMLLC classified as a disregarded entity (the default tax classification for SMLLCs), the IRS does not consider you to be self-employed and does not automatically assume you receive all of your company's profits. (Owners of disregarded entities are taxed on the entire amount of income earned each year by their businesses regardless of whether they take that money for themselves.) Instead, each year you receive from your company whatever amount of money you choose, and you, personally, are taxed only on that amount. (The company is taxed on the remainder, and possibly more.)
When your SMLCC is taxed as a C corporation, you'll ordinarily work as its employee. This enable you to choose how your business profits are paid to you--either as a dividend or employee salary. (Other less common options also exist, such as receiving a bonus over and above a salary or receiving money from the business as a loan.) In contrast to a dividend, a corporation can deduct as a business expense any salary it pays to an employee. Thus, employee salary is taxed once—at the employee's individual rates. As a result, most SMLLC owners who choose to have their businesses taxed as corporations receive their money as a salary.
Another advantage to being classified as an employee of your SMLLC is that it can provide you with tax-free employee benefits and deduct the expense. This includes:
Be aware, however, that if you are your SMLLC's employee and pay yourself a salary, your SMLLC must follow the same tax rules as any other employer. This includes withholding payroll and income taxes from your pay, depositing the money with the IRS, and filing quarterly employer tax returns (Form 941); if your payroll due is less than $2,500 in a quarter you can deposit the money with your quarterly employment tax return instead of monthly. Your SMLLC may also be required to pay state unemployment insurance taxes.
Example: Charlie's SMLLC manufactures and sells shipping boxes. Charlie has elected to have the company taxed as a C corporation. For the most recent tax year, the business had $90,000 in net profits before subtracting any money Charlie would take for himself. Charlie wanted $60,000 of the money for himself, but didn't want to pay double taxes on it. So, rather than taking it as a dividend, Charlie paid himself a monthly salary of $5,000. Each month, he made sure to calculate how much his company had to withhold for Social Security, Medicare, and federal income tax, and he put that money in a separate account. Each quarter, he sent the withheld money to the IRS electronically using the Form 941 e-file system. Also, on a quarterly basis, his SMLLC made estimated tax payments using Form 1120-W. At tax time, the company filed a separate tax return to pay taxes, at the 21% corporate tax rate, on the $30,000 of profit remaining after Charlie's payments to himself. Charlie also reported and paid taxes on the $60,000 annual salary he received on his personal Form 1040.
You can find additional information on how SMLLCs are taxed in other articles in the SMLLC section of Nolo's website. Many elements of paying corporation taxes, as well as paying yourself from an SMLLC taxed as a C corporation, can be tricky. For answers to detailed questions, check irs.gov or consult with a tax professional.