LLC and S-Corp Structures for Tax Purposes
LLC’s (classified for tax purposes as a sole proprietorship or a partnership) and S corporations are considered pass-through business entities. This means the taxes of the business are reported on the business tax return but are passed through to the individual owners. The owners receive a tax form that’s included with the owner’s tax return.
LLC
A limited liability company registers with a state but the LLC isn’t recognized by the IRS as a tax entity. LLC owners are called “members.” The IRS treats LLCs either as corporations, partnerships, or as part of the LLC owner’s tax return (a “disregarded entity”). How an LLC pays federal income tax depends on how many owners it has:
An LLC with one owner (called a single-member LLC) is considered a separate (disregarded) entity, and it pays taxes in the same way as a sole proprietor. An LLC with multiple members is considered by default to be taxed as a partnership.
S Corporation
An S corporation (sometimes called a “Subchapter S corporation”) is a special kind of corporation. Instead of the corporation paying federal income taxes, these taxes are passed through to the personal tax returns of the owners (shareholders).
Starting an LLC vs. Starting an S Corporation
An LLC is formed when it registers with a state by filing articles of incorporation with the state in which the owner or owners want to do business. An S corporation becomes one when the business elect S corporation status by filing Form 2553 with the IRS.
Reporting Federal Income Taxes
Single-member LLC members pay income taxes on the net income of their business, through their personal tax return. Multiple-member LLCs report total partnership taxes on IRS Form 1065. This form is an information return. Generally, the partnership doesn’t pay tax on its income; the income is passed through to the individual partner (LLC member) tax returns. S corporations report federal income taxes on IRS Form 1120-S. Shareholders pay their taxes based on their share of the S corporation’s taxable income. Information from the Schedule K-1 for each multiple-member LLC member and S corporation shareholder is included in Schedule E of the owner’s tax return.
Self-Employment Taxes
Owners of single-member LLCs are considered to be self-employed, and they must pay self-employment tax (Social Security and Medicare tax) on their share of the profits of the business. S-corporation shareholder income isn’t self-employment income and it isn’t subject to self-employment tax.
Qualified Business Income Deduction
LLC members and S corporation shareholders may be eligible for a qualified business income deduction. This deduction allows a deduction of up to 20% of their qualified business income, in addition to standard business deductions.
Limitations on Business Losses
Business owners who don’t materially participate in their businesses may not be able to claim all losses on their tax returns. Owners of LLCs and S corporations are both subject to passive-loss limitation rules.
