A Guide for Taxes as a Multi-Member LLC

A Guide for Taxes as a Multi-Member LLC

Multi-member limited liability companies (LLCs) are treated like a “pass-through entity” by the IRS. The profits and losses of an LLC pass through its members (owners) and are reported on their personal tax returns.

That means that for tax purposes members of multi-member LLCs are treated and taxed as a partnership unless they choose to be taxed as a corporation. Read more about the taxes of a multi-member LLC.

Understanding Multi-Owner LLC Taxation

LLC members, whether they are one or many, don’t pay taxes on the business income, but on their share of the profits which they attach with Schedule E onto their personal income tax return Form 1040.

Taxes on Distributive Shares

The operating agreement of a multi-member LLC is an important document because each member’s share of the profits or losses is set out in there. This is called the distributive share and each member gets their proportion according to their percentage of interest in the business. If the members of an LLC decide to not share out the profits as specified in the agreement, it is known as a special allocation.

No matter how the distributed shares are divided among the members of the LLC, each member pays taxes on their proper distributive share, even if the members are not taking their distributions because they need the money to grow their business.

Other IRS Filing Requirements

Even though co-owned LLCs do not pay income taxes, they must file Form 1065 with the IRS. This informational return is the same as the one filed by partnerships and is used by the IRS to review the income reported by each member of a multi-owned LLC. LLCs also provide every member with a Schedule K-1. This form has a breakdown of their profits or losses according to their share. This information is then attached with Schedule E to their individual Form 1040.

Self-Employment Taxes

Self-employment taxes must be paid by most LLC owners on their rightful share of profits to the IRS unless they are not actively managing the LLC. The amount due for self-employment tax is reported on Schedule SE annually with each member’s tax return.

Deductible Expenses

Legitimate business expenses can be deducted by the members to help lower the profits reported to the IRS. Deductible expenses include startup costs, equipment, marketing, vehicles, and travel. Some categories of expenses, like travel and entertainment, are an example, have additional terms and spending limits. Some need to be capitalized.  Expense deductions help to lower both income and self-employment taxes of LLC members.

State Fees and Taxes

Any state taxes due also consider the LLC as a “pass-through” entity, and are paid by the

members. In some states, there is an annual franchise tax or annual registration fee on LLCs. These two are not income-related fees.

Sales and Use Tax, Withholding Tax, Unemployment Insurance Tax, and Gross Receipts Tax are some of the other taxes LLC owners pay.

When to Consider being Taxed like a Corporation?

Most businesses choose the LLC structure for personal liability protection, and they just use the default tax structures that disregard the entity entirely. However, some LLCs need to regularly retain their profits within the business and they prefer to choose one of the two corporate tax classifications. These are either a C corporation or an S corporation.

C corporations pay tax on their gross income minus all their operating expenses. This is at a lower rate than individual income tax. However, any money that is not retained in the business and distributed to the members is also taxed on their individual income tax as dividends at the rate for capital gains. This leads to double taxation. Some fringe benefits can be offered by the LLC to members and employees, these include stock options and stock ownership plans, and these are not subject to double taxation.

S corporations can be beneficial to a company if it has significant earnings. However, the business must generate enough profit to pay members a reasonable salary, plus at least $10,000 in distributions. Businesses taxed as S corps also have expensive accounting and payroll costs because they are subject to more scrutiny by the IRS.

Conclusion

Multi-member LLCs are considered a partnership by default but have a choice of business structures that benefit their members while offering them personal asset protection. If needed, a multi-member LLC can file for C corp or S corp classification with the IRS.

January 9th, 2021 by