By default, LLCs are taxed based on the number of Members (owners). So, the IRS treats an LLC with one Member (a Single-Member LLC) differently than an LLC with two or more Members (a Multi-Member LLC).
If you just apply for an EIN, the IRS will determine your LLC’s tax status based on the number of Members.
Alternatively you can apply for an EIN, and then file Form 8832 (C-Corporation) or Form 2553 (S-Corporation). These forms ask the IRS to tax your LLC as an S-Corporation or C-Corporation instead of the default status.
Single-Member LLC taxes
Default status: Single-Member LLCs are what’s called a Disregarded Entity. This means The IRS looks at the owner to determine the LLC’s default tax status.
A disregarded entity has “subtypes”. The subtypes depend on who the owner is.
- If the LLC is owned by a US citizen or a US resident, the LLC is taxed like a Sole Proprietorship
- If the LLC is owned by a non-US resident, the LLC is taxed the same way as the individual who is a non-US resident
- If the LLC is owned by another company, the LLC is taxed like a branch/division of the parent company
Multi-Member LLC taxes
Default status: By default, all Multi-Member LLCs are taxed like a Partnership.
Note: Multi member LLCs are not Disregard Entities.
However if a Multi-Member LLC is owned by a married couple (in a community property state), the LLC can elect to be taxed as a Qualified Joint Venture.
Both Single-Member LLCs and Multi-Member LLCs have pass-through taxation. This means the profits from the LLC pass-through to the owners’ personal tax return.
LLC Disregarded Entity
You’ll also hear the term “LLC Disregarded Entity” and wonder what this means.
The term “disregarded entity” is only used by the IRS and applies to single-member LLCs (which have not elected to be taxed as a C-Corporation or S-Corporation).
When the IRS “disregards” an LLC, it means that, although the LLC and its owner are separate entities (for liability purposes), the IRS “disregards” them and just taxes the LLC however its owner is taxed. The IRS treats the owner and the LLC as one and the same.
Don’t worry though, this doesn’t affect the asset protection provided by your LLC. For liability purposes, your personal assets will still remain protected.
If the single-member LLC is owned by a person, the disregarded LLC is taxed like a Sole Proprietorship and the owner will report the LLC’s activities on either a Schedule C, Schedule E, and/or a Schedule F.
If a single-member LLC is owned by another company, the disregarded LLC’s activities should be reported on the parent company’s tax return (and marked as a branch or division of the parent company).
Husband and Wife LLC Tax Treatment
By default, the IRS taxes a Husband and Wife LLC as a Partnership just like Multi-Member LLCs. However, they can also elect to be taxed as a Qualified Joint Venture instead.
As a Qualified Joint Venture, the Husband and Wife LLC will be taxed by the IRS as a “single unit”. The spouses only need to file one return, which translates to increased tax savings, reduced accounting fees, record-keeping and other paperwork.
Also, under a Qualified Joint Venture, the husband and wife can get extra credit for social security and Medicare without paying additional taxes.
Very Important Note: Only Husband and Wife LLCs formed in “Community Property” states are eligible to be taxed as Qualified Joint Ventures. These states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
There are additional requirements and restrictions for the Qualified Joint Venture LLC. For more information, please see this lesson: Qualified Joint Venture.
LLC Taxed as Sole Proprietorship
This is the default IRS tax classification for single-member LLCs.
You don’t need to file anything with the IRS in order to make this election.
For federal tax purposes, the profits and losses of the LLC “flow through” to the owner’s individual personal income return (Form 1040).
For more information, please see LLC taxed as Sole Proprietorship.
LLC Taxed as a Partnership
This is the default IRS tax classification for multi-member LLCs.
You do not need to file anything with the IRS in order to make this election. For federal tax purposes, the profits and losses of the LLC “flow through” to the owner’s individual personal income return (Form 1040).
For more information, please see LLC taxed as a Partnership.
LLC Taxed as an S-Corporation
This section is written in the context of single-member LLCs taxed as an S-Corp (as it’s easier to understand), but the same concept applies to multi-member LLCs taxed as an S-Corp.
An LLC doesn’t need to keep its default tax classification with the IRS. If an LLC would like to be taxed as an S-Corporation, it must file Form 2553.
(related article: instructions for LLC taxed as S-Corp)
The biggest advantage of a single-member LLC taxed as an S-Corp is how the owner will pay self-employment taxes (social security and medicare taxes).
The owner of an LLC taxed as a Sole Proprietorship will pay self-employment taxes on all profits in the company. For simplicity, self-employment taxes are 15.3% of net income (income after expenses). So if a single-member LLC has $100,000 in net income, the owner will pay $15,300 in self-employment tax.
With an LLC taxed as an S-Corp, the owner also becomes an employee of the company and must take a reasonable salary. That reasonable salary is subject to the 15.3% self-employment tax, but the leftover profits (called distributions) are not subject to self-employment taxes.
So for this example, if the LLC has $100,000 in net income, but the owner takes a $60,000 salary, the owner will only pay $9,180 in self-employment tax ($60,000 x 15.3%). The remaining $40,000 is not subject to self-employment tax (for a savings of $6,120).
Now, it’s not all pure tax savings. The LLC owner will incur additional expenses being taxed as an S-Corporation. These include payroll processing, payroll tax returns, additional bookkeeping, accounting fees, and filing Form 1120-S corporate tax return. These expenses can range from $1,500 to $2,500 so there will usually still be self-employment tax savings for LLCs with net income of at least $75,000 to $80,000. Of course, the higher your profits, the higher your tax savings.
There are additional advantages and disadvantages not covered in this brief overview so make sure to speak to your accountant before making any changes to your LLC’s tax classification.
LLC Taxed as a C-Corporation
An LLC doesn’t have to keep its default tax classification with the IRS. If an LLC would like to be taxed as a C-Corporation, it must file Form 8832.
(related article: LLC taxed as a C-Corp)
Note: LLCs taxed as C-Corps are not that common and usually only apply to a small range of business owners. We are including this information for reference, but please speak with an accountant about the best tax classification for your LLC.
An advantage of an LLC taxed as a C-Corp is something called “income splitting”. This is when a business owner makes enough money that they can leave some in the business. They take a reasonable salary, but not such a big salary that it completely eliminates the company’s profits. By “splitting the income”, an owner can keep themselves in a lower tax bracket. However, this strategy is not for the inexperienced. You’ll need to work with your tax professional closely to make sure you do not become subject to the Accumulated Earnings Tax (for leaving profits in the company for too long).
The biggest disadvantage of an LLC taxed as a C-Corp is what’s known as “double taxation”. Unlike a pass through entity (LLC taxed as Sole Proprietorship, LLC taxed as Partnership, and LLC taxed as S-Corporation), an LLC with C-Corp tax classification must file a return federally with the IRS and the owners must also file federally with the IRS. This means you are taxed on the corporate level as well as the personal level.
There are other advantages and disadvantages not listed above, but we are keeping this section as a brief overview since 95% of our readers do not benefit from having their LLCs taxed as C-Corporations. This type of taxation usually applies to much larger and sophisticated businesses; not small business owners.