An LLC is a legal chameleon. It doesn't have its own tax identity. Instead, it adopts the tax rules of other entities. Explore how this works and discover the mathematical impact of making an election.
Before you elect anything, the IRS automatically classifies your LLC based on the number of owners ("members"). This is your starting point.
For tax purposes, the LLC "doesn't exist." All income and expenses flow directly to your personal tax return (Form 1040).
The LLC must file an informational return to report income/losses, but the entity itself pays no income tax. Partners receive a K-1.
You aren't stuck with the default. An LLC can elect to be taxed as a Corporation. Compare the four operational modes below.
The "Keep it Simple" Approach
The IRS ignores the LLC boundary for tax purposes. You and the business are one. This is the simplest, lowest-compliance option.
The most common reason LLCs elect S-Corp status is to save on Self-Employment (SE) taxes.
In a standard LLC, you pay 15.3% SE tax on everything. In an S-Corp, you only pay it on your Salary, not your Distributions.
IRS requires a "reasonable salary." Typically 40-60% of profits depending on industry.
*Estimates for demonstration only. Assumes 15.3% SE Tax cap limits not hit for simplicity in visual comparison. Consult a CPA.
Unless you need to retain huge earnings for growth or attract venture capital, the C-Corp election often results in less money in your pocket due to taxes being levied twice on the same dollar.
The Corporation pays 21% flat federal tax on profit immediately.
When remaining profit is distributed to you, you pay 15% or 20% (Long Term Capital Gains rates) on that money.
Result: Effective tax rates can exceed 40%, often higher than pass-through rates for small businesses.