Does an LLC Need a Separate Tax Return?

by Tom Chmielewski; Updated September 26, 2017
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Though a limited liability company does not pay a corporate tax unless it elects to be taxed as a C corporation, in most circumstances an LLC will need to file a return. The returns and forms it must file with the Internal Revenue Service depend on how the LLC is organized, whether it has employees, and its choice of tax treatment made by its members, as owners of LLCs are called.

Income Returns

The IRS does not recognize an LLC for income tax purposes, and instead treats an LLC as a “disregarded entity,” a partnership or a corporation. A multi-member LLC, which accepts the default classification of partnership must file form 1065, U.S. Return of Partnership Income. If the LLC elects to be classified as an S Corporation, it must file Form 1120S, U.S. Return for an S Corporation. With both of these forms, all the company’s income is attributed to the LLC members, and each partner needs to report his share of income on a personal tax return. If the LLC elects to be taxed as a C Corporation, it must file Form 1120, U.S. Corporation Income Tax Return.

No Return Needed

The IRS treats a single-member LLC by default as a disregarded entity and not a business separate from its owner. The company itself does not file any income tax returns. Instead, the owner reports all business income and expenses as a sole proprietor on Schedule C. Profit and Loss from Business, on her personal 1040 income tax return. A single-member LLC, however, does have the option to elect to be treated as a corporation.

Tax Repercussions

The owner of a single-member LLC filing as a sole proprietor must pay a self-employment tax in addition to income tax on any profit the company makes. For an LLC taxed as a partnership, each member manager, those partners who are actively involved in running the business, must also pay self-employment tax on their shares of profit. Passive members who only invest in the company but do not substantially participate in its operations are not subject to a self-employment tax. When taxed as an S Corporation, member managers must be paid a “reasonable wage” that meets industry standards in which the LLC operates. The LLC pays employment tax and collects payroll withholdings, but any share of profit a member manager receives separate from a wage is considered passive income and not subject to self-employment taxes. When taxed as a C corporation, the LLC itself pays a corporate tax on its profits. Shares of that profit are taxed again when distributed to LLC members.

Advantages

For start-up companies, LLCs’ treated as sole proprietorships or partnerships offer simplicity in filing requirements and a “pass-through” taxation that avoids the double tax imposed on C corporations. Even though member managers pay self-employment tax on their of profits, the rate is equal to employment taxes on wages to cover Medicare and Social Security. When profits increase enough that a member manager’s share would be higher than the reasonable wage requirement, electing to be taxed as an S corporation can provide significant tax savings as money can be diverted from earned income to passive income. While an LLC taxed as a C corporation faces a corporate tax on its profits, it doesn’t have to distribute its entire profits to members. “Income splitting” as it's called allows the company to balance retained earnings and dividends to avoid pushing a member into a higher tax bracket.

Other Forms

If an LLC has employees, it will need to file Form 941, Employer’s Quarterly Federal Tax Return to report wages and withholdings. The company will also need to submit W-2s to employees, and file form 940, Employer’s Annual Federal Unemployment Tax Return.

About the Author

Tom Chmielewski is a longtime journalist with experience in newspapers, magazines, books, e-books and the Internet. With his company TEC Publishing, he has published magazines and an award-winning multimedia e-book, "Celebration at the Sarayi." Chmielewski's design skills include expertise in Adobe Creative Suite's InDesign and Photoshop. He holds a Bachelor of Arts in English from Western Michigan University.

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