A limited liability company (LLC) is a form of business organization recognized by all states. Forming an LLC provides limited liability protection for owners (called "members"), who are taxed at their personal tax rates.
How a limited liability company pays income tax depends on whether the LLC has one member or several members and whether the LLC elects to be treated as a different business form for tax purposes.
To start an LLC, you must register with the state where you want to do business, by filing Articles of Organization (or similar application) with the state.
The Internal Revenue Service doesn't recognize LLCs for tax purposes. So how does an LLC pay income tax?
How a Single-member LLC Pays Income Taxes
The IRS considers a single-member LLC as a disregarded entity. In other words, the LLC is not separate from the owner for income tax purposes. Being a disregarded entity means that the LLC is taxed in the same way as a sole proprietorship. That is, the information about the LLC's income and expenses, and its net income is calculated by preparing a Schedule C. The net income from the Schedule C is brought over to the owner's personal tax return (Form 1040 or 1040-SR).
How a Multiple-member LLC Pays Income Taxes
An LLC that has more than one member typically pays income tax as a partnership. The partnership itself does not pay taxes directly to the IRS; the individual partners pay tax based on their share of ownership in the partnership.
Reporting your income as an LLC member has several steps:
Step 2: You receive a Schedule K-1 is prepared for each partner, showing your share of the profit or loss of the partnership.
Step 3: You must ransfer Schedule K-1 information to Schedule E - Supplemental income. The Schedule K-1 you receive from your LLC breaks down your income into different types, and each type of income goes in a specific place on Schedule E.
Step 4: Include the income from your Schedule E in the right place on your Form 1040 or 1040-SR.
The IRS considers income from rental real estate, including Airbnb-type income, as passive income. Losses from normal business activity aren't limited, but losses from passive income are limited if you don't participate in the business, so you must report this income separately.
Income Tax for LLC's classified as Corporations or S Corporations
Some LLCs choose to be taxed as a corporation or S corporation. Usually, businesses usually make this choice (called an "election") because it results in lower taxes for high-income individuals. The election is submitted through IRS Form 8832 - Entity Classification Election.
Making this tax election doesn't change how your LLC operates; it just changes the way you pay taxes. Your LLC continues to operate as an LLC, following the company's operating agreement.
LLCs and Rental Real Estate Income
If all or part of your income as an LLC member LLCs must use Schedule E to report supplemental income for Form 1040 instead of Schedule C. Supplemental income is income from rental real estate or royalties owned by the LLC, including Airbnb-type activities.
LLC Owners and Self-Employment Tax
LLC owners commonly get income from business operations. This income is considered self-employment income and it's subject to self-employment tax (Social Security and Medicare). You must complete Schedule SE to calculate how much you owe, based on your business net income. The total is added to your other income on your personal tax return.
Schedule E income from rental real estate income (Box 2 of Schedule E) generally isn't subject to self-employment tax. It's considered passive activity (not active, as a business) and LLC member income from this passive activity may be subject to passive loss limitation rules.
How LLC's Pay State Income Tax
Each state has a different way of classifying LLC's for state income tax purposes. After you have figured out your LLCs tax status, you can go to your state's department of revenue to find out how your state might be taxed.
You will need to look at two factors:
- What is the tax based on? Most states use the federal income tax liability as a basis, but states modify that basis for their state tax.
- How does the LLCs tax classification (sole proprietor, partnership, S corporation, or corporation) affect the state income tax?
Some states call their income tax a franchise tax. Other states may charge LLCs a gross receipts tax rather than an income tax.
This article is a general overview not tax or legal advice. LLC taxes are complicated, and every business situation is different. If you are thinking about forming an LLC or you want to change its tax status, talk to your tax professional first.