How Limited Liability Companies Are Taxed

All businesses must pay taxes, with the amount determined by the level of your profits and the tax rate. If you have a limited liability company (LLC), you get the benefit of deciding to file your federal and state income taxes as a corporation or as an individual, so you can choose the status that provides the best result for you.

For example, say you and your business partner drive together to a client meeting and on the way injure someone in a car crash. The injured party then sues your company.

“While the LLC might have to pay damages in a lawsuit, if the LLC is operated legitimately, you and your business partner’s personal assets can be protected,” said Hal Shelton, SCORE mentor, angel investor and author of an Amazon best-selling book, .

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1. Make your business genuine.

Legitimacy, as stated above, means much more than having the LLC certificate from the state where you applied for it. You need to operate your business as a separate entity from your personal life, says Shelton. That means having a business bank account, a credit card only used for business expenses and even stationery with your company’s name on the letterhead. Including these components in the structure help make your LLC successful.

“Otherwise, lawyers (in case of a lawsuit) may say your LLC is a sham,” said Shelton. “If they are successful with this claim, your personal assets could be at risk.”

Once you’ve created an authentic LLC, you need to know how it will be taxed. [In debt and in need of relief? Check out our best picks and reviews ofcompanies.]

2. Understand how income tax is determined.

An example of the individual method would be a company that made $100,000 in profits last year and has three owners: Owner A and Owner B each received 30% of the profits, while Owner C is entitled to 40%. This allocation was previously agreed upon and is included in the LLC operating agreement. The LLC fills out IRS Form 1065 and sends it to the IRS – this is known as an information return, because the three owners will be paying the taxes. The LLC also prepares a Schedule K-1 for each of the owners showing their share: Owners A and B got $30,000, while Owner C received $40,000.

“Then each of the owners must file a Form 1040 with an attached Schedule C, where they will show their share of the LLC profits,” said Shelton. “The IRS will then match the Form 1065 from the LLC and the three owners’ Schedule Cs to make sure all the taxes have been paid.”

That’s the pass-through and where the actual taxes are paid. [Looking for ? Check out our reviews and best picks on our sister site, Business News Daily.]

3. Give every entity its share.

All but seven states in the U.S. require residents to pay state income tax. Those 43 states have different tax rates. The amount you pay depends on your overall income and your state’s tax rate.

An LLC also pays the same taxes as any business would. If you have employees, you’ll pay wage taxes (Social Security, Medicare and unemployment insurance). Selling a product or service that’s subject to sales tax means you need to remit those taxes to your state and any other state you sell in, says Shelton. An LLC that owns real estate might incur property tax. The amount of these taxes is calculated according to a different formula for each one.

“Because the process of how LLCs are taxed is not intuitive, I recommend you seek counsel by contacting a SCORE mentor,” said Shelton. “You can meet face to face [or] via email, telephone or video conference.”

You can visit SCORE to find a mentor. Surround yourself with advisors and counselors, because the more knowledge you can tap into, the better you’ll run your business.

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