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How LLC Taxes Work

LLCs As C Corporations
LLCs can be C corporations, S Corporations, single-member or  other permutations.
LLCs can be C corporations, S Corporations, single-member or other permutations.

It's often preferable to have your multi-owner LLC treated as a C corporation for tax purposes. It can save you big bucks, which means you can use more of your profits to reinvest in your company and its growth. Unlike regular LLCs, corporations are considered by the IRS to be separate tax entities from the owners. Thus, a C corporation pays its own federal and state taxes; the money is not run through the owners' individual income taxes. This means business owners are not subject to self-employment taxes, which can be a great savings.

In addition, C corporation profits can be distributed in cash to owners as dividends or W-2 wages (money earned from an employer), assuming the person is performing legitimate, business-related work. W-2 wages are generally the preferred method, since the recipient is only taxed once on his wages. Dividends, however, are double-taxed; they're taxed first as part of the LLC's corporate income, and then again on the owner/shareholder's income tax return when they're handed out. So it's helpful that a C corporation can pay out some of its profits via wages [sources: Akalp, Entrepreneur].

Finally, your overall tax bill is often lower when your LLC operates as a C corporation. Why is this? As of 2014 in the U.S., tax law stipulates that the first $50,000 of an LLC's profits be taxed at the beginning federal corporate tax rate -- 15 percent. That's a lower percentage than often is seen in single-member and multi-members LLCs. Let's look at an example of how that can affect a company's overall tax bill.

Ed and Bob own a graphic design LLC that earns a profit of $75,000. They each own 50 percent of the business. If their company is operating as a multi-owner LLC, or partnership, they would each record $37,500 on their personal income taxes. Assuming they both filed as single people, they'd each owe $5,231.25 according to 2014 tax rates, plus 15.3 percent in self-employment taxes ($5,737.50), for a total of $10,968.75 apiece and $21,937.50 together. That would leave $53,062.50 of their firm's profits for reinvestment [sources: Internal Revenue Service, Erb].

If Ed and Bob operated their business as an LLC functioning as a C corporation, however, no profits would be run through their personal income taxes, and so no self-employment taxes would be levied. Instead, the first $50,000 of their profits would be taxed at the beginning corporate tax rate of 15 percent, and the next $25,000 at 25 percent. This would result in a tax bill of just $13,750, leaving $61,250 for reinvestment. This example assumes Ed and Bob are leaving all profits in the corporation and not taking any out as W-2 wages or dividends [source: Internal Revenue Service].