LLC owners report business income and losses on their personal tax returns.
Updated by Diana Fitzpatrick, J.D. · New York University School of Law
Updated by Amanda Hayes, Attorney · University of North Carolina School of Law
A limited liability company (LLC) isn't a separate tax entity like a corporation; instead, it's what the IRS calls a "pass-through entity," like a partnership or sole proprietorship. All of the profits and losses of the LLC "pass through" the business to the LLC owners (called members), who report this information on their personal tax returns. The LLC itself doesn't pay federal income taxes, although some states impose an annual tax on LLCs.
How Is Income From an LLC Taxed?
The IRS treats your LLC like a sole proprietorship or a partnership, depending on the number of members in your LLC.
Single-Member LLCs
The IRS treats single-member LLCs (LLCs with one owner) as sole proprietorships for tax purposes. This means that the LLC itself doesn't pay taxes and doesn't have to file a return with the IRS.
As the sole owner of your LLC, you must report all profits (or losses) of the LLC on your 1040 tax return. Depending on your business, you might attach one or more of the following schedules to your 1040:
- Schedule C to report business income
- Schedule E to report income from rental properties and investments, and
- Schedule SE to pay self-employment tax.
Even if you leave profits in the company's bank account at the end of the year—for instance, to cover future expenses or expand the business—you must pay income tax on that money.
Multi-Member LLCs
The IRS treats co-owned LLCs as partnerships for tax purposes. Like single-member LLCs, co-owned LLCs don't pay taxes on business income; instead, the LLC owners each pay taxes on their share of the profits on their personal income tax returns (with Schedule E attached). Each LLC member's share of profits and losses, called a distributive share, should be set out in the LLC operating agreement.
Dividing up the profits between members. Most operating agreements provide that a member's distributive share is in proportion to their percentage interest in the business. For instance, if Jimmy owns 60% of the LLC, and Luana owns the other 40%, Jimmy will be entitled to 60% of the LLC's profits and losses, and Luana will be entitled to 40%.
If you'd like to split up profits and losses in a way that's not proportionate to the members' percentage interests in the business, it's called a special allocation. For more information on special allocations, including the IRS rules you'll have to follow if you wish to make them, see our article on making special allocations.)
Taxes are assessed on the entire distributive share. However members' distributive shares are divvied up, the IRS treats each LLC member as though the member receives their entire distributive share each year. So, each LLC member must pay taxes on their whole distributive share, whether or not the LLC actually distributes all (or any of) the money to the members. The practical significance of this IRS rule is that even if LLC members need to leave profits in the LLC—for instance, to buy inventory or expand the business—each LLC member is liable for income tax on their rightful share of that money.
File Form 1065 with the IRS. Even though a co-owned LLC doesn't pay its own income taxes, it must file Form 1065 with the IRS. This form—the same one that a partnership files—is an informational return that the IRS reviews to make sure that LLC members are reporting their income correctly. The LLC must also provide each LLC member with a Schedule K-1, which breaks down each member's share of the LLC's profits and losses. In turn, each LLC member reports this profit and loss information on their individual Form 1040, with Schedule E attached.
Consider Electing Corporate Taxation for Your LLC
If you'll regularly need to keep a substantial amount of profits in your LLC (called "retained earnings"), you might benefit from electing corporate taxation. Any LLC can choose to be treated like a corporation for tax purposes by filing IRS Form 8832, Entity Classification Election, and checking the corporate tax treatment box on the form.
All regular "C" corporations are currently taxed at a flat 21% rate on all their profits. This rate is lower than the top five individual income tax rates, ranging from 22% to 37%, which would otherwise apply to LLC members at various income levels. Thus, LLC owners can save money on their overall taxes by choosing to be taxed as a C corporation.
However, these potential savings can prove elusive because money distributed from a C corporation to its owners is subject to double taxation. First, the 21% corporate tax must be paid, and second, the shareholders must pay individual income tax on their dividends at capital gains rates, which range up to 23.8%.
However, profits not paid out as dividends (called "retained earnings") aren't subject to double taxation. In addition, electing corporate taxation can allow an LLC to offer owners and employees various tax-advantaged fringe benefits, stock options, and stock ownership plans—none of which are subject to double taxation.
Estimating and Paying Income Taxes
LLC members are considered self-employed business owners rather than employees of the LLC so they're not subject to tax withholding. Instead, each LLC member is responsible for setting aside enough money to pay taxes on that member's share of the profits. The members must estimate the amount of tax they'll owe for the year and make quarterly payments to the IRS (and to the appropriate state tax agency, if there's a state income tax) in April, June, September, and January.
Do LLC Members Pay Self-Employment Tax?
LLC members aren't employees so no contributions to the Social Security and Medicare systems are withheld from their paychecks. Instead, most LLC members are required to pay these taxes—called "self-employment taxes" when paid by a business owner—directly to the IRS.
The current rule is that any owner who works in or helps manage the business must pay this tax on their distributive share (rightful share of profits). However, owners who aren't active in the LLC—that is, those who have merely invested money but don't provide services or make management decisions for the LLC—can be exempt from paying self-employment taxes on their share of profits. The regulations in this area are a bit complicated; but if you actively manage or work in your LLC, you can expect to pay self-employment tax on all LLC profits allocated to you.
Each member who's subject to the self-employment tax reports the amount due on Schedule SE, which must be submitted annually with their tax return. LLC owners (and sole proprietors and partners) pay twice as much self-employment tax as regular employees because regular employees' contributions to the self-employment tax are matched by their employers. However, LLC members also get to deduct half of the total amount from their taxable income, which saves a few tax dollars.
As of 2023, the self-employment tax rate for business owners is 15.3%, which consists of the following:
- 12.4% for Social Security on earnings up to $160,200
- 2.9% for Medicare on all earnings, and
- an additional 0.9% Medicare tax rate for all income above $250,000 (married filing jointly), $125,000 (married filing separately), or $200,000 (all other taxpayers).
Check the IRS website for annual net income threshold amounts. For more on self-employment taxes, see our article on paying estimated taxes.
What Are LLC Tax Deductions?
As you no doubt already know, you don't have to pay taxes—income taxes or self-employment taxes—on most of the money that your business spends. You can deduct ("write off") your legitimate business expenses from your business income, which can greatly lower the profits you must report to the IRS.
Deductible expenses include:
- start-up costs
- automobile and travel expenses
- equipment costs, and
- advertising and promotion costs.
For information about allowable expenses and deductions, read about the top tax deductions for your small business.
LLC owners might also be eligible for an income tax deduction for pass-through entities established by the Tax Cuts and Jobs Act. Starting in 2018, the owner of a pass-through entity, including a single or multi-member LLC, can deduct up to 20% of their net business income from their taxes.
For example, suppose the net income from a single-member LLC business is $100,000. The owner can deduct up to $20,000 (or 20% of $100,000) from their income taxes. So, they'll only have to pay taxes on $80,000.
However, if taxable income exceeds an annual threshold—an amount adjusted for inflation each year—the deduction is limited to the greater of:
- 50% of the amount paid to employees of the entity, or
- 25% of employee payments plus 2.5% of the value of the depreciable business property.
Additionally, the deduction is phased out for taxpayers involved in various types of service businesses. Also, this deduction can't be taken by regular C Corporations or LLCs that elect to be taxed as C corporations.
Do LLCs Pay State Taxes?
Most states tax LLC profits the same way the IRS does: The LLC members pay taxes to the state on their personal returns, while the LLC itself doesn't pay a state tax.
Additional taxes in some states. A few states, however, do charge the LLC a tax based on the amount of income the LLC makes, in addition to the income tax its owners pay. For instance, California levies a tax on LLCs that make more than $250,000 per year; the tax ranges from about $900 to $11,000.
Annual fees in some states. In addition, some states impose an annual LLC fee that's not income-related. This fee might be called a "franchise tax," an "annual registration fee" or a "renewal fee." In most states, the fee is about $100, but California exacts a hefty $800 "minimum franchise tax" per year from LLCs (note this tax is waived for the LLC's first year for LLCs formed in 2021, 2022, or 2023).
Before forming an LLC, find out whether your state charges a separate LLC tax or fee. For more information, check the website of your state's secretary of state, department of corporations, or your state's revenue or tax department. For more state-specific information on LLCs, see our state guides to forming an LLC and LLC tax and filing requirements.
Seeking Professional Help
LLCs have many tax benefits, including flexibility in how they're taxed. With these different options, you can find the type of taxation that fits your small business and costs you the least. If you're knowledgeable of business and personal taxes or have experience with LLC finances, you can likely choose a tax structure for your business and pay and report taxes yourself. But if you don't feel comfortable navigating the process yourself, you should reach out to a tax professional for help.
If you're thinking about forming an LLC and need help understanding your tax options, you should talk to a business lawyer. They can help explain the advantages and disadvantages of each tax entity. A business attorney can also help you draft an operating agreement to reflect each member's share of the LLC's profits. For more specific or complex questions, you should speak with a tax attorney. They can help you maximize your business deductions and explain your tax obligations. You should also consider working with an accountant or other tax expert. They can file your forms for you and help ensure you're meeting your tax deadlines.
