Business Formation

How LLCs Are Actually Taxed (It's Not What Most People Think)

An LLC (limited liability company) is a legal structure, defined by state law. It is not, by itself, a tax classification — the IRS doesn't have an "LLC" tax form. What actually happens is that the IRS taxes an LLC according to one of a few default classifications, unless you file paperwork to choose a different one.

Default: single-member LLC

If you're the only owner, the IRS disregards the LLC for tax purposes by default — your business income and expenses are reported directly on your personal return (Schedule C), and you pay self-employment tax on the net profit, the same as a sole proprietor.

Default: multi-member LLC

With more than one owner, the LLC is taxed as a partnership by default. The LLC files an informational partnership return (Form 1065), and each owner receives a Schedule K-1 reporting their share of the profit or loss, which they then report on their personal return.

Electing S-corporation status

An LLC can elect to be taxed as an S-corporation instead of its default classification. The appeal is usually payroll tax: as an S-corp, an owner who works in the business is paid a reasonable salary (subject to payroll tax), and remaining profit can be distributed without additional self-employment tax. This can reduce the overall tax bill for a profitable business, but it adds real complexity — payroll, a separate S-corp return (Form 1120-S), and a defensible "reasonable salary."

There's no universal profit threshold where an S-corp election automatically makes sense — it depends on your specific numbers, and the extra compliance cost can outweigh the savings for a smaller business. This is worth reviewing with your specific figures rather than deciding from a rule of thumb.

Electing C-corporation status

An LLC can also elect C-corp taxation, though this is less common for small businesses — the company pays its own corporate tax, and any distributed profit is taxed again on the owner's personal return ("double taxation"). This occasionally makes sense for businesses planning to reinvest most profit rather than distribute it, or raise outside investment.

Not sure which classification your LLC should actually use, or whether an election would help? That's exactly the kind of question worth a real conversation about your specific numbers.

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