How LLC Members Are Taxed

A limited liability company (LLC) is a legal structure for a business. But, unlike a partnership or corporation, an LLC isn't a tax entity. Instead, an LLC has various options for how it and its members can be taxed. We'll explore the different ways an LLC and its members can be taxed, which kinds of taxes LLCs need to worry about, and how an LLC can lower its taxes.

How Are LLCs Taxed?

LLCs are unique creatures in the taxing world. An LLC is generally taxed as a pass-through entity by default, but you can elect to have your LLC taxed as a corporation. The way your income is taxed will depend on the number of members your LLC has and the elections you make, if any.

If your LLC qualifies, your LLC can be classified as one of the following tax entities for income tax purposes:

• a partnership
• a disregarded entity
• a corporation, or
• an S corporation.

Multi-member LLCs are classified as partnerships by default. Single-member LLCs (LLCs with only one owner) are classified as disregarded entities, meaning the LLC is treated as the same entity as its owner. Both partnerships and disregarded entities are types of pass-through entities (PTEs). A "PTE" is a type of entity where the income passes through the business to the owners, who pay taxes on their share of the income. With a PTE, only the owners are taxed and not the entity itself.

While your LLC will be taxed as a partnership or disregarded entity by default, you can elect to have your LLC taxed as a corporation or an S corporation. You'll make these elections by filing the appropriate form with the IRS.

Single-Member LLCs Taxed as Disregarded Entities

The IRS treats single-member LLCs as sole proprietorships or disregarded entities for tax purposes. As a result, the LLC itself doesn't pay taxes and doesn't have to file a separate return with the IRS.

As the sole owner of your LLC, you must report all profits (or losses) of the LLC on your 1040 tax return. Depending on your business, you might attach one or more of the following schedules to your 1040:

• Schedule C to report business income
• Schedule E to report income from rental properties and investments, and
• Schedule SE to pay self-employment tax.

Even if you leave profits in the company's bank account at the end of the year—for instance, to cover future expenses or expand the business—you must pay income tax on that money.

You can read our article on how single-member LLCs pay income tax for more details.

Multi-Member LLCs Taxed as Partnerships

The IRS treats co-owned LLCs as partnerships for tax purposes. Like single-member LLCs, co-owned LLCs don't pay taxes on business income; instead, the LLC owners each pay taxes on their share of the profits on their personal income tax returns (with Schedule E attached). Each LLC member's share of profits and losses, called a "distributive share," should be set out in the LLC operating agreement.

Dividing up the profits between members. Most operating agreements provide that a member's distributive share is in proportion to their percentage interest in the business. For instance, if Jimmy owns 60% of the LLC, and Luana owns the other 40%, Jimmy will be entitled to 60% of the LLC's profits and losses, and Luana will be entitled to 40%.

If you'd like to split up profits and losses in a way that's not proportionate to the members' percentage interests in the business, it's called a special allocation. For more information on special allocations, including the IRS rules you'll have to follow if you wish to make them, see our article on making special allocations.)

Taxes are assessed on the entire distributive share. However members' distributive shares are divvied up, the IRS treats each LLC member as though the member receives their entire distributive share each year. So, each LLC member must pay taxes on their whole distributive share, whether or not the LLC actually distributes all (or any of) the money to the members. The practical significance of this IRS rule is that even if LLC members need to leave profits in the LLC—for instance, to buy inventory or expand the business—each LLC member is liable for income tax on their rightful share of that money.

File Form 1065 with the IRS. Even though a co-owned LLC doesn't pay its own income taxes, it must file Form 1065 with the IRS. This form—the same one that a partnership files—is an informational return that the IRS reviews to make sure that LLC members are reporting their income correctly.

The LLC must also provide each LLC member with a Schedule K-1, which breaks down each member's share of the LLC's profits and losses. In turn, each LLC member reports this profit and loss information on their individual Form 1040, with Schedule E attached.

Electing Corporate Taxation for Your LLC

If you'll regularly need to keep a substantial amount of profits in your LLC (called "retained earnings"), you might benefit from electing corporate taxation. Any LLC can choose to be treated like a corporation for tax purposes by filing IRS Form 8832, Entity Classification Election, and checking the corporate tax treatment box on the form.

All regular "C" corporations are currently taxed at a flat 21% rate on all their profits. This rate is lower than the top five individual income tax rates, ranging from 22% to 37%, which would otherwise apply to LLC members at various income levels. Thus, LLC owners can save money on their overall taxes by choosing to be taxed as a C corporation.

However, these potential savings can prove elusive because money distributed from a C corporation to its owners is subject to double taxation:

• First, the 21% corporate tax must be paid, and
• second, the shareholders must pay individual income tax on their dividends at capital gains rates, which range up to 23.8%.

However, profits not paid out as dividends (called "retained earnings") aren't subject to double taxation. In addition, electing corporate taxation can allow an LLC to offer owners and employees various tax-advantaged fringe benefits, stock options, and stock ownership plans—none of which are subject to double taxation.

Electing to Be Taxed as an S Corporation

Another option for LLCs is S corporation taxation. Having your LLC taxed as an S corporation can have several advantages, but it's not for everyone. An S corporation, like a partnership and sole proprietorship, is a PTE. The S corporation doesn't pay taxes on its earnings. Instead, the LLC members (now shareholders) pay taxes on their distributions and salaries.

S corporation vs. regular corporation: Unlike a regular corporation, an S corporation is a PTE and isn't subject to double taxation. However, an S corporation is relatively limited in the tax deductions it can make. For example, for the most part, S corporations can't deduct the cost of fringe benefits provided to employees as corporations can.

S corporation vs. partnership: Both tax entities are PTEs. But shareholders in an S corporation can avoid paying self-employment taxes. Because active shareholders (LLC members) in an S corporation are typically considered employees, the S corporation will pay payroll taxes instead. Under a partnership tax structure, active LLC members must pay self-employment taxes (as discussed later).

An S corporation also has tighter restrictions regarding which businesses can elect to be treated as S corporations. Your LLC can elect to be treated as an S corporation only if:

• every shareholder (member) is a U.S. resident or citizen
• each member is an individual, trust, or estate and not a corporation or partnership
• the LLC has 100 or fewer shareholders (members), and
• the S corporation has only one class of stock.

If you're considering electing to be taxed as an S corporation, you should talk to a tax attorney or other tax professional. They can walk you through the benefits and drawbacks of the S corporation tax status to help you decide if this choice is right for your business.

Reporting and Paying Income Taxes

The IRS forms you file will depend on how your LLC is structured.

As an individual, you'll report and pay your income taxes received from your business on your personal tax return. You'll use Form 1040, Individual Income Tax Return, and its applicable schedules to report your individual taxes.

If your LLC is taxed as a disregarded entity or partnership, then you'll report your share of the business profit and losses on your personal return. If your LLC is taxed as a corporation, then you'll need to report any dividends you received from your LLC. If your LLC is taxed as an S corporation, you must report any distributions received from your LLC.

Finally, if you're considered an employee of your LLC, then you'll also need to report your salary or wages.

Depending on your tax structure and obligations, you might also need to make estimated payments throughout the year. You should talk to a tax professional if you have questions about when and how to report and pay your business and personal taxes.

You'll also be responsible for filing the corresponding state tax return to report your business income. Typically, how you're taxed at the federal level will be how you're taxed at the state level. For example, if you're taxed as a partnership at the federal level, then your state will also recognize you as a partnership for tax purposes.

How to Reduce Your LLC Taxes

One of the hallmark features of an LLC is its tax advantages. Because an LLC has various tax options, you can pick the best taxing structure for your business. In addition to choosing the best tax structure for your business, you can also take advantage of various business deductions.

Tax Deductions: Deducting Business Expenses

As you no doubt already know, you don't have to pay taxes—income taxes or self-employment taxes—on most of the money that your business spends. You can deduct ("write off") your legitimate business expenses from your business income, which can greatly lower the profits you must report to the IRS.

Deductible expenses include:

• start-up costs
• automobile and travel expenses
• equipment costs, and
• advertising and promotion costs.

For information about allowable expenses and deductions, read about the top tax deductions for your small business.

20% Pass-Through Entity Tax Deduction

LLC owners might also be eligible for an income tax deduction for PTEs established by the Tax Cuts and Jobs Act (TCJA). The owner of a PTE, including a single or multi-member LLC, can deduct up to 20% of their net business income from their taxes.

For example, suppose the net income from a single-member LLC business is $100,000. The owner can deduct up to $20,000 (or 20% of $100,000) from their income taxes. So, they'll only have to pay taxes on $80,000.However, if taxable income exceeds an annual threshold—an amount adjusted for inflation each year—the deduction is limited to the greater of:

• 50% of the amount paid to employees of the entity, or
• 25% of employee payments plus 2.5% of the value of the depreciable business property.

Additionally, the deduction is phased out for taxpayers involved in various types of service businesses. Also, this deduction can't be taken by regular C Corporations or LLCs that elect to be taxed as C corporations.

Possible State Pass-Through Entity Tax Election

Many states now allow PTEs—like LLCs taxed as partnerships or S corporations—to pay income tax at the entity level. In the states that offer this option, qualifying LLCs elect to be taxed at the entity level. This election is often called a "pass-through entity tax election."

Under this election, an LLC reports and pays income tax at the entity level (called a "PTE tax") on behalf of all its members. The LLC members then claim a credit on their personal state tax return for the tax already paid on their behalf by the LLC. LLCs are typically taxed at a flat rate.

The real advantage behind this election is lowering an individual's federal tax burden. The TCJA imposed a $10,000 cap on how much an individual could deduct their state and local taxes (SALT) from their federal return. By electing to have your LLC taxed at the entity level, you can bypass your LLC income counting toward your $10,000 SALT deduction limit.

Every state has different requirements and limitations. So you'll need to check your state's laws regarding the PTE tax to see whether your LLC is eligible to make this election.

Read our article on deducting your state income taxes with a PTE for more details.

State Taxes on LLCs

Most states tax LLC profits the same way the IRS does: The LLC members pay taxes to the state on their personal returns, while the LLC itself doesn't pay a state tax (unless the LLC elects a different taxing structure).

Additional taxes in some states. A few states, however, do charge the LLC a tax based on the amount of income the LLC makes, in addition to the income tax its owners pay. For instance, California levies a tax on LLCs that make more than $250,000 per year. As of 2024, the tax ranges from about $900 to just under $12,000.

Annual fees in some states. In addition, some states impose an annual LLC fee that's not income-related. This fee might be called a "franchise tax," an "annual registration fee" or a "renewal fee." In most states, the fee is about $100, but California exacts a hefty $800 "minimum franchise tax" per year from LLCs. (California's minimum franchise tax is waived for the LLC's first year for LLCs formed in 2021, 2022, or 2023.)

Before forming an LLC, find out whether your state charges a separate LLC tax or fee. For more information, check the website of your state's secretary of state, department of corporations, or your state's revenue or tax department. For more state-specific information on LLCs, see our state guides to forming an LLC and LLC tax and filing requirements.

Sales Tax for LLCs

If your LLC sells taxable goods or services, your business will be responsible for collecting and reporting sales tax to your state and local governments. Every state (and city) has its own requirements for how to collect and report sales tax. Even if you're not organized or located within a state, you might still owe sales tax to that state as a remote seller.

Check out your state and local sales tax requirements for more details on whether you need to collect and report sales tax, what forms you need to file, and how often you need to file.

Payroll Taxes vs. Self-Employment Taxes

If your LLC has employees, you'll need to pay an associated employment tax. Typically, an LLC member who participates in the business management is a kind of employee. But this employee classification has some nuance. Depending on your LLC's tax classification, LLC members can be considered either "employees" or "self-employed."

Your classification will determine how you (as an LLC member) and your LLC will be taxed on your income.

• If your LLC is taxed as a partnership or a disregarded entity, then active LLC members are considered self-employed. The LLC members will be responsible for paying a self-employment tax.
• If your LLC is taxed as a corporation or S corporation, then active LLC members are considered employees. The LLC and its members will share in paying payroll taxes.

You'll be responsible for paying both federal and state payroll or self-employment taxes.

Payroll Tax Rate

LLC members who are considered employees of their LLC will share the burden of payroll taxes with the LLC. For LLC members, these payroll taxes will be deducted directly from their paychecks.

If you make more than $200,000 in a calendar year, then you (as the LLC member) will be solely responsible for an additional 0.9% Medicare surtax on that income. Like the other payroll taxes, this surtax will be withheld from your wages.

Self-Employment Tax Rate

LLC members aren't employees so no contributions to the Social Security and Medicare systems are withheld from their paychecks. Instead, most LLC members are required to pay self-employment taxes.

The current rule is that any owner who works in or helps manage the business must pay this tax on their distributive share (rightful share of profits). However, owners who aren't active in the LLC—that is, those who have merely invested money but don't provide services or make management decisions for the LLC—can be exempt from paying self-employment taxes on their share of profits. The regulations in this area are a bit complicated; but if you actively manage or work in your LLC, you can expect to pay self-employment tax on all LLC profits allocated to you.

Each member who's subject to the self-employment tax reports the amount due on Schedule SE, which must be submitted annually with their tax return. LLC owners (and sole proprietors and partners) pay twice as much self-employment tax as regular employees because regular employees' contributions to the self-employment tax are matched by their employers. However, LLC members also get to deduct half of the total amount from their taxable income, which saves a few tax dollars.

As of 2024, the self-employment tax rate for business owners is 15.3%, which consists of the following:

• 12.4% for Social Security on earnings up to $160,200
• 2.9% for Medicare on all earnings, and
• an additional 0.9% Medicare tax rate for all income above $250,000 (married filing jointly), $125,000 (married filing separately), or $200,000 (all other taxpayers).

Check the IRS website for annual net income threshold amounts. For more on self-employment taxes, see our article on paying estimated taxes.

Seeking Professional Help

LLCs have many tax benefits, including flexibility in how they're taxed. With these different options, you can find the type of taxation that fits your small business and costs you the least. If you're knowledgeable of business and personal taxes or have experience with LLC finances, you can likely choose a tax structure for your business and pay and report taxes yourself. But if you don't feel comfortable navigating the process yourself, you should reach out to a tax professional for help.

If you're thinking about forming an LLC and need help understanding your tax options, you should talk to a business lawyer. They can help explain the advantages and disadvantages of each tax entity. A business attorney can also help you draft an operating agreement to reflect each member's share of the LLC's profits.

For more specific or complex questions, you should speak with a tax attorney. They can help you maximize your business deductions and explain your tax obligations. You should also consider working with an accountant or other tax expert. They can file your forms for you and help ensure you're meeting your tax deadlines.

FAQ About LLC Taxation

Here are some other questions you might have about LLC taxes.

• What are the benefits of an LLC?
• How do LLC owners avoid taxes?
• Do LLC members have to pay self-employment tax?
• Which state taxes does my LLC need to pay?

What are the benefits of an LLC?

One of the primary benefits of forming an LLC is its tax advantages. While your LLC will be taxed as a partnership or disregarded entity by default, you have other taxing options. You can elect to be taxed as a regular corporation or as an S corporation. This flexibility allows you and your other LLC owners to choose the best taxing structure for your business. Each tax entity has its advantages and disadvantages so make sure you consider all of your options before making your choice.

In addition to its tax advantages, an LLC offers other benefits:

• LLCs are relatively easy to set up and maintain.
• They can also have multiple owners or just one
• LLCs offer their owners limited liability protection—so, typically, LLC owners aren't responsible for the debts or obligations taken on by the LLC.
• LLCs have a flexible management structure. The LLC can be run by the members or appointed managers.

To learn more about LLCs, see our article about the advantages of an LLC.

How do LLC owners avoid taxes?

You can limit your tax burden by deducting your business expenses. You can deduct many of your business's startup costs as well as ongoing expenses. Common deductible business expenses include:

• commercial property and mortgage interest
• commercial rent
• utilities
• vehicles
• equipment like computers or machinery
• advertising expenses
• legal and accounting fees
• office supplies, and
• travel expenses.

If you work from home, then you can also take advantage of the home office deduction. And, unless you elect to have your LLC taxed as a regular corporation, you can use the 20% pass-through deduction for small business owners. If you live in one of the 36 states with a PTE tax, you can deduct the state and local income taxes you pay from your federal taxes.

Read about the top tax deductions for your small business for a breakdown of available business tax savings.

There are many ways to save on taxes as a small business owner. To maximize your savings, talk to a tax professional. They can help you identify deductions and areas of savings that you might not even know about.

Do LLC members have to pay self-employment tax?

Maybe. If your LLC is treated as a partnership or disregarded entity (which your LLC will be by default unless you make a different tax election), then active LLC members will need to pay a self-employment tax.

Passive investors likely don't need to pay this tax. But if an owner participates in running the business, then they'll be subject to the self-employment tax. Running the business can mean making management decisions, providing services on behalf of the LLC, managing the finances, and more.

If you're not sure whether you need to pay the self-employment tax, you should talk to a business attorney or tax professional.

Which state taxes does my LLC need to pay?

The taxes your LLC is responsible for will largely depend on your business's location and activities. For instance, some states don't have an income tax. Other states don't have a sales tax. You'll need to check your state's laws to understand your state tax burden. The following are the common taxes your business might need to pay:

• income tax
• sales tax
• payroll taxes
• franchise taxes
• annual or biennial renewal fees, and
• licensing fees.

You might owe similar taxes to your city or county as well. For more on your state obligations, see our article on LLC annual report and tax filing requirements.