How LLC Taxes Work

LLCs As S Corporations

Your final option for operating your LLC is to run it as an S corporation, which you can do if your business has multiple owners/shareholders, although not more than 100. An S corporation is sort of a combination of a corporation and pass-through entity, as no corporate income taxes are levied on the LLC's profits, yet no self-employment taxes are, either. Running your LLC as an S corporation is generally a good option if you and your co-owners intend to take some or all of the profits out of the business [sources: Dahl, Entrepreneur]. Here's how it works.

Like LLCs-as-C-corporations, LLCs-as-S-corporations can make cash payments to owners via wages or dividends. Any wages or salaries paid must be fair -- e.g., the industry standard -- and not an amount artificially high or low. The LLC is also responsible for FICA (Federal Insurance Contributions Act) taxes, such as Medicare and Social Security and other withholding requirements.

At year's end, any cash profits that aren't paid out via wages and salaries are then parceled out equally to owner/shareholders as dividends. The dividends are considered passive dividend income, and are taxed on the co-owners' individual income tax returns at a lower rate than their income is. If the business registers a loss, each co-owner would include her share of the loss on her individual income tax returns. The LLC then files an 1120S tax return (U.S. Income Tax Return for an S Corporation) [sources: BizFilings, Dahl].

One final point about LLCs as S corporations, which is also true for LLCs as C corporations, is that they can issue stock options and ownership plans, which may be beneficial. But tax law also requires both types of corporations to follow more procedures, such as creating bylaws, holding formal board meetings, taking accurate minutes and so forth.

Taxes are never a simple issue, nor is determining the best structure for your business. If you think forming an LLC will save you money, consult with an expert such as your accountant, who will be able to help guide you.

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