LLCs are a specific business entity in the United States. They provide limited liability protection for owners (called "members"). These members are then taxed at their personal tax rates. LLCs may also elect taxation, which means the LLC can be treated as a different business form for tax purposes. This is extremely helpful when avoiding double taxation, or receiving other tax benefits that a corporation or sole proprietorship may not have the privilege of.
Because a Limited Liability Company (LLC) is not a separate tax entity like a corporation, it is taxed differently. LLCs are known as disregarded entities. The government treats LLCs as a sole proprietorship automatically. This means that the IRS considers an LLC a “pass-through entity.” This is similar to a partnership or sole proprietorship.
If you decide to form your LLC with no other members, you are considered a single-member LLC. The IRS treats one-member LLCs as sole proprietorships for tax purposes. This means that the LLC itself does not pay taxes and does not have to file a return with the IRS.
If you form an LLC with one or more people, then the IRS treats your LLC as a partnership for tax purposes. Similar to one-member LLCs, co-owned LLCs do not pay taxes on business income. Multi-member LLCs pay taxes on their share of the profits on their personal income tax returns (with Schedule E attached).
There are a few steps to reporting income as an LLC member:
LLCs can choose to be taxed by various different entities. This is known as tax “election” because it often results in lower taxes for high-income individuals. Making this tax election doesn't change how your LLC operates. Instead, it only changes the way you pay taxes. Your LLC continues to operate as an LLC, following the company's operating agreement.
Automatically an LLC will be taxed as either a sole proprietorship or a partnership. This depends on whether you are a single member or multi-member LLC.
If you plan to regularly keep a substantial amount of profits in your LLC, this is called "retained earnings". This may mean that you will benefit from electing corporate taxation. Any LLC can choose to be treated like a corporation for tax purposes. All you need to do is file an IRS Form 8832.
In 2018 all corporations have been taxed a flat 21% rate on all their profits. This is lower than the top three income tax rates, which range from 32% to 37%. If you are already in a higher tax bracket, as an LLC owner you can save money overall by being taxed as a C corporation.
What may be confusing about this is that distributed from a C corporation to its owners is subject to double taxation. This means that first the 21% corporate tax must be paid off of the total earnings, while the shareholders must then pay individual income tax on their dividends at capital gains rates (these can range up to 23.8%). What is important to note is that retained earnings are not subject to double taxation.
Electing corporate taxation can also allow an LLC to offer owners and employees various tax-advantaged fringe benefits, stock options, and stock ownership plans, which are not subject to double taxation.
One of the best parts of taxation for an LLC is the ability to claim tax deductions. These include:
New Mexico is known as a “tax-friendly” state. Most states tax LLC profits similar to how the IRS does. The state sales tax rate in New Mexico is currently 5.125%. Overall, the total tax rate can be as high as 9.0625%.
Because LLC members are not employees, there will be no contributions to the Social Security and Medicare systems withheld from paychecks. This leads to most LLC owners being required to pay these taxes. These are known as "self-employment taxes" and will be paid exactly to the IRS.
Any owner who works in or helps manage the business must pay this tax on their own share of the profits. If you are an owner that is not active in the LLC, but rather are an investor, you do not necessarily need to pay self-employment taxes. Although this can be confusing, if you actively manage or work in your LLC, you should expect to pay self-employment tax.
LLCs file and pay taxes on their personal tax returns. The LLC itself does not necessarily pay state taxes, but instead, all profits are passed through to the owners. The owners will then pay taxes on their own profits, through their own personal income tax return.