Before forming an LLC, many entrepreneurs ask about the standard LLC tax rate to see if this form of entity is a solid option for their new business. This is an excellent question and one that can be best answered by exploring what an LLC is and how it is taxed.
The LLC (limited liability company) business entity type is one of the most popular selected by small business owners. It shields the owner’s personal assets from the liabilities of the business and may result in some tax savings to boot. The LLC is an entity formed according to state statute, and it has flexibility in how income taxes are applied at the federal level. The IRS gives LLC members (its owners) the option to be taxed as a sole proprietorship (or partnership if multiple owners) or a corporation.
An accountant, tax attorney, or another qualified tax advisor can advise you on which of those choices will serve LLC members’ business and personal purposes the best. I strongly recommend that you talk to a tax professional because your income tax treatment can make a significant impact on your company’s bottom line.
Below, I’ve shared some information to give you a general understanding as you prepare for your conversation with your tax advisor.
Federal Income Tax for an LLC Taxed as a Sole Proprietor or Partnership
By default, the LLC is considered a disregarded entity for tax purposes, meaning it gets “pass-through taxation.” The LLC itself does not pay taxes or file its own tax returns, and due to this, there is no formal LLC tax rate. Instead, income from the business passes through to the company’s owners who then claim the profits on their personal income tax forms (via Schedule C).
For the tax year 2018, individual income tax rates are as follows (according to the tax law passed on December 22, 2017).
Federal Income Tax Rate – Individuals
| Single | Married Filing Jointly* | Married Filing Separate | Head of Household | |
|---|---|---|---|---|
| 10% | $1-$9,525 | $1-$19,050 | $1-$9,525 | $1-$13,600 |
| 12% | $9,526-$38,700 | $19,051-$77,400 | $9,526-$38,700 | $13,601-$51,800 |
| 22% | $38,701-$82,500 | $77,401-$165,000 | $38,701-$82,500 | $51,801-$82,500 |
| 24% | $82,501-$157,500 | $165,001-$315,000 | $82,501-$157,500 | $82,501-$157,500 |
| 32% | $157,501-$200,000 | $315,001-$400,000 | $157,501-$200,000 | $157,500-$200,000 |
| 35% | $200,001-$500,000 | $400,001-$600,000 | $200,001-$300,000 | $200,001-$500,000 |
| 37% | Over $500,000 | Over $600,000 | Over $300,000 | Over $500,000 |
In this tax scenario, the LLC members must pay self-employment taxes (Medicare and Social Security) on the business income they report that’s related to an active trade. An LLC set up for a passive activity, such as a real estate investment, would not be subject to self-employment taxes on those profits (which are reported on Schedule E).
So, let’s say Julia is an independent human resources consultant who has formed an LLC for her business. If the LLC earns $50,000 in profits this year, Julia will pay taxes on that $50,000 at her individual tax rate and pay self-employment taxes (currently 15.3 percent for the calendar year 2018) on that income.
A multiple-member LLC that opts to be taxed as a partnership reports its business income on a 1065 partnership tax return. Income taxes are then calculated according to each member’s share of the partnership profits and then paid by each member at that person’s individual tax rates. Each partner also pays self-employment taxes on their share of the profit. Same as with a single-member LLC, self-employment taxes don’t apply to an LLC that is set up for only passive business activity.
Note that some LLCs might discover pass-through tax treatment to be particularly advantageous because of the new tax rules that allow some businesses to deduct up to 20 percent of some or all of their qualified business income. So, Julia in the example above might find her tax obligations are less than what I outlined. I would advise her to talk with a tax advisor to determine whether she’s eligible for the deduction and how much of a deduction will apply to her.
Federal Income Tax for an LLC Taxed as a C Corporation
An LLC may elect to be treated as a corporation for tax purposes by filing IRS Form 8832. With corporate tax treatment, the LLC must file tax return 1120 and pay taxes at the 2018 corporate tax rate of 21 percent. LLC profits are not subject to self-employment taxes, but any profits distributed to owners as dividends are taxable at the appropriate capital gains/dividend tax rates.
Long-Term Capital Gains and Dividends Tax Rate
| Single | Married Filing Jointly | Head of Household | |
|---|---|---|---|
| 0% | $0-$38,600 | $0-$77,200 | $0-$51,700 |
| 15% | $38,601-$425,800 | $77,201-$479,000 | $51,701-$452,400 |
| 20% | Over $425,800 | Over $479,000 | Over $452,400 |
An LLC taxed as a corporation must also pay payroll taxes on wages and salaries paid to the LLC members who work in the business.
Consider this example to get a feel for how the tax obligations might work out for an LLC taxed as a corporation:
Jim owns an auto repair business, which earned $90,000 in profit. As a C corporation, his company would pay would $18,900 in business income tax (assuming the 21 percent tax rate). If Jim then takes home any of that profit as a dividend, he also would owe taxes at the applicable dividend rate on the dividend payment.
Federal Income Tax for an LLC Taxed as an S Corporation
An LLC has another the option, too: electing for S corporation treatment (by submitting IRS Form 2553). An S corp files a business tax return (1120S), but unlike a C corporation, the company doesn’t pay corporate income tax on its profits. Instead, the LLC members are each taxed on their respective shares of the company’s earnings at the appropriate tax rates for individuals. Those profit distributions are not subject to self-employment tax. LLC members that work in the business must earn reasonable wages from the LLC. The LLC must pay payroll taxes on those wages, and the LLC members must pay self-employment taxes on their wage income.
To illustrate how this works, imagine three brothers start a barbecue catering business, and each owns one-third of the company. They form an LLC and elect to be taxed as an S corporation. After their first year, the LLC earns $75,000 in profit. Instead of the catering business paying income tax on that profit, each brother will report his share of the profits ($25,000) on his individual tax return and pay income tax at the applicable individual tax rate. Likewise, if there were a loss in the business’s first year, each brother would report his share of the loss on his individual tax return.
Read More About Payroll: What is Payroll?
LLC State Income Tax
At the state level, an LLC’s income tax treatment will depend on how the state classifies the LLC and other factors.
Many states will classify the LLC the same way the IRS does for tax purposes—usually with company profits passing through to the members’ individual tax returns. Alternatively, if the LLC elected for C corp or S corp tax treatment with the IRS, most states will handle the LLC’s taxes as such.
State income tax rates vary from state to state, and some states charge LLCs an annual fee (often called a “franchise tax” or “annual registration fee”) for the privilege of operating there. Other state fees might also apply.
I encourage business owners to check with their state’s Department of Revenue or Secretary of State office to know what to expect.
An LLC Offers More Than Just Tax Flexibility
As you’re considering which structure to choose for your business, realize that tax flexibility is just one of the ways you might find forming an LLC advantageous. Other features that many entrepreneurs find attractive are the business structure’s management flexibility and relatively simple compliance requirements. To fully understand which type of business entity will deliver you and your company the most favorable tax, legal, and operational outcomes, talk with an attorney and a tax professional for information and guidance.
Also, don’t forget that after you’re ready to form your LLC or incorporate your business, CorpNet is here to help you with all your business registration and compliance filings. Contact us to learn more about how we can save you time and money!
