LLC Taxes: How LLCs Are Taxed and Your Options

Single-member LLC (one owner): By default, the IRS treats a single-member LLC as a "disregarded entity." This means the LLC itself does not file a tax return. Instead, you report all business income and expenses on Schedule C (Profit or Loss from Business) attached to your personal Form 1040. The LLC's profits are taxed at your individual income tax rate, plus self-employment tax (15.3% on the first $168,600 and 2.9% above that).

Multi-member LLC (two or more owners): By default, a multi-member LLC is taxed as a partnership. The LLC files Form 1065 (partnership tax return) and issues a Schedule K-1 to each member showing their share of income, deductions, and credits. Each member then reports their K-1 amounts on their personal tax return. Like a single-member LLC, profits are subject to self-employment tax for members who actively participate in the business.

The key advantage of default LLC taxation is simplicity. There is no separate corporate tax — profits pass through to your personal return and are taxed once. This avoids the double taxation that C-Corps face (corporate tax on profits, then individual tax on dividends).

An LLC can elect to be taxed as an S-Corp by filing IRS Form 2553. This does not change your LLC's legal structure — it only changes the tax treatment. The LLC files a corporate tax return (Form 1120-S) and issues K-1s to members.

The S-Corp advantage centers on self-employment tax savings. As an S-Corp, you must pay yourself a "reasonable salary" (subject to payroll taxes), but any profits above your salary are distributed as "distributions" that are not subject to self-employment tax (15.3%). On a business netting $120,000, paying a $60,000 salary and taking $60,000 in distributions saves approximately $9,180 in self-employment taxes.

The S-Corp disadvantage is added complexity and cost. You must run payroll (processing fees of $500-$2,000/year), file quarterly payroll tax returns, file a separate corporate tax return (Form 1120-S), and comply with S-Corp rules (max 100 shareholders, one class of stock, US-resident shareholders only). The breakeven point where S-Corp savings exceed the added costs is typically $40,000-$60,000 in net profit.

The IRS scrutinizes S-Corp salaries. If your salary is unreasonably low compared to what similar professionals earn, the IRS can reclassify distributions as wages and assess back payroll taxes plus penalties. Work with a CPA to set an appropriate salary.

An LLC can also elect C-Corp taxation by filing IRS Form 8832. This is less common for small businesses because of double taxation — the LLC pays corporate tax (21% federal rate) on profits, and then members pay individual tax on dividends received. However, C-Corp taxation can be advantageous in specific situations.

C-Corp taxation may make sense if: you want to retain earnings in the business and the 21% corporate rate is lower than your personal rate, you are reinvesting all profits into growth and not taking distributions, or you plan to eventually raise venture capital or go public (investors prefer C-Corp tax treatment for certain investment structures).

The Qualified Small Business Stock (QSBS) exclusion under Section 1202 allows shareholders of C-Corps to exclude up to $10 million in capital gains from federal tax if certain requirements are met. This can be extremely valuable for startups planning an exit and is only available with C-Corp taxation.

Self-employment (SE) tax is the Social Security and Medicare tax that self-employed individuals pay. The rate is 15.3% on the first $168,600 of net self-employment income (2024), plus 2.9% on income above that threshold. This is in addition to your regular income tax.

For a default LLC, all net business income is subject to SE tax. On $100,000 in net profit, your SE tax bill is approximately $14,130. This is the biggest single tax hit most LLC owners face, and it is the primary reason many LLC owners consider the S-Corp election once profits reach the $40,000-$60,000 range.

With S-Corp taxation, only your salary is subject to payroll taxes (the equivalent of SE tax). Distributions above your salary are exempt. This can save $3,000-$15,000+ per year depending on your net income and salary level.

An additional 0.9% Medicare surtax applies to self-employment income above $200,000 (single) or $250,000 (married filing jointly). High-earning LLC owners should factor this additional tax into their planning.

State taxes on LLCs vary enormously. Nine states have no individual income tax (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, Wyoming), which means LLC profits that pass through to your personal return avoid state income tax entirely.

Several states impose LLC-specific taxes or fees beyond the normal income tax. California charges an $800/year minimum franchise tax plus a fee based on gross receipts over $250,000. New York imposes a filing fee based on New York-source gross income. Illinois charges $75/year for an annual report.

If your LLC operates in multiple states, you may owe taxes in each state where you have "nexus" (sufficient business activity). This typically includes states where you have physical presence, employees, or significant sales. Multi-state taxation is complex and usually requires a CPA's guidance.

When choosing where to form your LLC, consider the total state tax burden — not just the filing fee. A state with a low filing fee but high annual taxes (like California) may be more expensive long-term than a state with a higher filing fee but no annual LLC tax.

LLC owners must make quarterly estimated tax payments to the IRS (and usually to their state) if they expect to owe $1,000 or more in taxes for the year. The payment deadlines are April 15, June 15, September 15, and January 15 of the following year.

Estimated payments cover both income tax and self-employment tax. Underpaying can result in penalties. The safe harbor rule allows you to avoid penalties by paying either 100% of your prior-year tax liability or 90% of your current-year liability (110% of prior year if your AGI exceeds $150,000).

Many LLC owners set aside 25-30% of net business income in a separate savings account for taxes. This percentage should be adjusted based on your total household income, deductions, and applicable state taxes. A CPA can help you calculate the right percentage.

If your LLC has elected S-Corp taxation, you will make estimated tax payments on your distributions and may also need to remit payroll taxes quarterly for your salary. The additional complexity of S-Corp tax payments is one reason to work with a payroll service.