LLC Taxation

LLC Taxation

How is an LLC taxed?

An advantage of the LLC is its tax flexibility. LLC members are allowed to select how the entity will be taxed.
An LLC may be classified for federal income tax purposes as either:

  • a sole proprietorship,
  • a partnership, or
  • a corporation.

Single member LLCs are treated the same as sole proprietorships. Profits are reported on Schedule C as part of your individual 1040 tax return. Self-employment taxes on LLC net income must be paid just as you would with any self-employment business.

Most multi-member LLCs elect to be treated as partnerships by the IRS and file IRS Form 1065. On this form, LLC profits are reported and allocated to each of the owners according to the LLC’s operating agreement. Each owner is given a Schedule K-1, which shows each owner’s share of LLC income or loss. The owner then reports and pays taxes on this income on the owner’s annual 1040 income tax return. It is important to note that as with sole proprietorships, all LLC profits are taxed to the owners, even if they are not actually distributed by the LLC. This situation can arise when the LLC needs to use its profits to pay ongoing expenses.

If pass-through taxation is not desired, an LLC may elect to be taxed as a corporation by completing IRS Form 8832. If this election is made, the LLC is taxed as a C corporation by the federal government. Because the corporate income tax rates for the first $75,000 of corporate taxable income are lower than the individual income tax rates that apply to the taxable income of non-corporate taxpayers, it is possible a net income tax savings can result from this tax election.

Please note that California LLCs are subject to an annual minimum franchise tax of $800 per year. The first payment must be made within 3 months of LLC formation.

What is franchise tax?

There is a minimum franchise tax of $800 for the privilege of doing business in California as an LLC. The tax is paid to the California Franchise Tax Board and is due on or before the 15th day of the fourth month of the taxable year. The first payment must be made to the California Franchise Tax Board within 3 months of LLC formation.

In addition to the minimum franchise tax, a California LLC must pay an annual fee based on the LLC’s total income, which is gross income plus the cost of goods sold. This fee ranges from $900 (for total income between $250,000-$500,000) to $11,790 (for total income of $5 million or more). Total income does not include allocations or distributions made to an LLC in its capacity as a member of, or holder of an economic interest in, another LLC, if that income was already subject to payment of the fee by the other LLC.

What is gross-receipts tax?

In addition to the minimum franchise tax, some California LLCs taxed as partnerships must pay an annual entity level tax based on the total income which is worldwide gross income, plus the co1qst of goods sold, paid or incurred in connection with the LLCs business. This gross-receipts tax only applies to LLCs grossing over $250,000 a year. The tax ranges from $900 to $11,790, as follows:

Total Income Annual Fee
Less than $250,000 $0
$250,000 to less than $500,000 $900
$500,000 to less than $1 million $2500
$1 million to less than $5 million $6000
$5 million or more $11,790


* The gross receipts tax does not apply to an LLC taxed as a corporation

What is self-employment tax?

Self-employment (SE) tax is a 15.3% tax on income. This rate, 15.3%, is a total of 12.4% for social security
(old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

Normally these taxes are withheld by your employer. However, if you are self employed, it is your responsibility to pay them yourself.

The SE tax rate for business owners is 15.3% tax of the first $90,000 of income and 2.9% of everything over $90,000.

S corporations have a significant advantage when it comes to the payment of SE taxes. In an S corporation, only the salary paid to the employee-owner is subject to employment tax. The remaining income that is paid as a distribution is not subject to SE tax under IRS rules.

Owners of LLCs, partnerships and sole proprietorships, however, pay SE tax on their respective share of profits rather than salary.

Certain types of LLC income, however, are not subject to self-employment tax. For example, rentals from real estate and capital gains are not considered to be self-employment income, so real estate LLCs often need not be concerned with self-employment tax.

What is a fiscal year?

A fiscal year is an accounting year, for tax purposes, that does not end on December 31. A fiscal year must end on the last day of a month (other than December).

An accounting year ending on December 31 is a calendar year.

What is an Employer Identification Number (EIN)?

The EIN, often referred to as the Federal Tax Identification Number, is a number that is assigned to a business by the Internal Revenue Service. An EIN is like a Social Security Number for a business. It is a requisite for certain business functions such as opening bank accounts or hiring employees.

I have a federal EIN for my existing business. Can I use the same one if I form an LLC?

No. If you already have an EIN (employer identification number) for your business, you must apply for a new one upon
formation of your LLC. Your new LLC may conduct business in exactly the same manner as your previous business entity,
but it is a new legal entity and a new taxpaying entity. Therefore, it must be assigned a new EIN.