Classifications tax for an Limited Liability Company
Because the LLC is an entity created by state statute (and not the federal government), it has flexibility for federal tax treatment. A single-member LLC can be taxed as a sole proprietorship or a corporation (either a C corporation or an S corporation). A multi-member LLC can be taxed as a partnership or a C corporation or an S corporation.
Below more information about the different tax treatments:
- As a sole proprietorship
- As a partnership
- As a C corporation
- As an S corporation
LLC taxed as a sole proprietorship or partnership
A single-member LLC is essentially taxed as a sole proprietor.
This classification falls into the "pass-through" taxation category—the business doesn’t file any tax forms. As the owner of the LLC, you report business income or loss on your personal tax forms (Schedule C).
If there are 2 members in the LLC, they will automatically be taxed as a partnership unless they have elected to do differently. When taxed as a sole proprietorship or partnership, income and deductions flow through to the members of the company
LLC taxed as a “C” Corporation
An LLC can elect to be treated as a corporation for tax purposes by filing Form 8832 with the IRS. The LLC files a corporate tax return 1120 and pays taxes on its profits at its corporate tax rate. If LLC profits are distributed to LLC owners in the form of dividends, those dividends are taxed again at the qualifying dividend rate (this is what’s known as double taxation).
The LLC profits are not subject to self-employment taxes. But an LLC treated as a C corporation is responsible for payroll taxes on any wages paid to LLC members who work for the business.
If you prefer to keep profits in the company rather than distributing end-of-the-year profits to owners, a C corporation would work. In this case, only the company is taxed on the profits; individual owners are not responsible for paying taxes on whatever money stays in the business.
Since the company is taxed separately from the individual, the income need not appear on one’s personal tax returns, giving the members additional privacy
LLC taxed as an “S” Corporation
In this last scenario, the LLC elects to be treated as an S corporation. The S corporation files an 1120S tax return, but the company’s profits are not subject to corporate income tax, as they are in the C corporation. Instead, individual LLC owners are taxed on their respective shares of the company’s profits (and profits are not subject to self-employment tax).
If an LLC owner works in the business, he must be paid a reasonable wage The tax code provides that a S-Corporation must not have a nonresident alien as a shareholder for his activities, and the LLC must pay payroll taxes on these wages.
This option can’t work if you are a foreigner: The tax code provides that a S-Corporation must not have a nonresident alien as a shareholder
Because the decision can have significant financial implications, discuss your particular situation with a tax adviser or CPA.