LLC Pass Through Taxation: What Is It?

Many small business owners and entrepreneurs take their business to the next level by forming a limited liability company.  This form of business entity provides protection from the risk of personal assets, but is much easier to form and manage than a corporation. Since the LLC has characteristics of a sole proprietorship and a corp, LLC members may wonder how the profits are taxed.  In this article we explain how LLC passes through taxation works.  Passthrough taxes are generally favorable to the members who can avoid double taxation.  We will analyze the regulations regarding pass through taxing and compare the pros and cons. Additionally, we compared various leading online platforms that assist with LLC organization, annual compliance, and tax consultations.  We present the leaders in the field and describe their value proposition, highlights, and features.

What is LLC Pass Through Tax?

Pass- through taxation refers to business tax systems where the entity profits are not taxed corporately but are passed through to shareholders who pay the taxes on their personal income tax.  This results in both simplicity in corporate accounting and savings for business owners.  This is because the profits are only taxed one time instead of corporate taxes on top of the personal taxes.  Sole proprietorships, simple partnerships, and LLCs are passed through organizations for tax purposes.

How is LLC Business Income Taxed?

Unlike a corporation, LLCs are not taxed at the corporate level.  The members are taxed on their share of the profit on their personal tax returns.

Single-Member LLCs

In the case of a single-member LLC, the income I reported on the members’ Schedule 1040 Schedule C.

Multi-Member LLCs

In the case of the multiple-member LLCs, the entity does file a tax return for informational purposes only – there is no tax to be paid.   Then the IRS issues a K-1 form to each member with the record of their share of the profit.  Members report this on their own individual tax returns.

Do You Have to Pay Taxes on Retained Earnings?

Retained earnings are the portion of an LLCs profit that are kept as funds in the business instead of being distributed to the members.  At an LLC, retained earnings are often referred to as Member’s Equity.  LLCs ordinarily pay their earnings to the members.  In some cases, the LLC members can decide to file as a corporation and utilize the ability to retain earnings.  The member equity is taxed as corporate profit in these cases.

Pros & Cons of pass through Taxation

Pass through taxation is generally beneficial to the taxpayer, as it avoids double taxation.  However, there are pros and cons in different circumstances 

Pros

Passing through taxation is simpler and less costly to keep records than corporate tax.  There are few accounting requirements compared to complex corporations.  Passthrough entities offer flexible management and ownership structure which make LLCs more attractive to small businesses.  Unlike corps, passthrough entities are only taxed one time – on the owners personal filings.  Corporations are taxed at the corporate tax rate then also shareholders pay personal tax on the profits. Passthrough entities also have a number of tax benefits and deductions that corps do not.

Cons

The major con of most pass through entities is lack of liability protection for sole proprietors and partners.  That is why the LLC is sometimes considered the best of both worlds.  As another con, LLC members are considered self employed for taxation purposes, and are thus subject to paying the self employment taxes. In some cases, high earners may not benefit as much from the passthrough because their marginal tax rate may be high.  When filing as a corporate tax, only the members salary is earned income, while the profits are dividends which are not subject to employment taxes but rather capital gains.  If the earners marginal tax rate is higher than capital gains levels, then passthrough may cost them more money. 

Do You Have to Choose to Pass through Taxation for Your LLC?

The vast majority of LLCs file as passthrough entities. But as the LLC members, you have the option to be taxed as either a passthrough entity or a corporation.  The decision depends on several factors.  They include the business goals, income level, and ownership structure.  Passthrough is the most popular choice because the LLC’s profits or losses are passed through to the members’ individual tax returns.  There are no corporate taxes on the business profits. Sometimes however, LLCs may wish to file as a corporation.  There are certain tax benefits of the corporation structure, especially for higher earners. 

Do LLCs Pay Corporate Income Tax?

Generally, Limited Liability Companies do not pay corporate income taxes.  As a default status, LLCs are taxed as a pass through entity.  In this arrangement, LLC members pay income tax one time – on their personal income tax returns. This avoids double taxation of  the profits.  

Do LLC Members Claim Business Income on Personal Tax Returns?

The profits from LLCs are generally taxed as passthrough profits.  This means that there is no corporate taxes paid on the profits initially.  Instead, the LLC distributes profits to each member based on their share of the company.  The profits are treated as business income and are thus taxed on the members personal income taxes.  The exception is when an LLC requests to be taxed as a corporation, which is uncommon.

The Top 2 LLC Services

There are many third party LLC organizers who provide filing services, with ZenBusiness and Northwest Registered Agent at the top of the field.  Each company has a devoted client base, a track record of success, and outstanding services.  Zenbusiness is modern, intuitive, adn packed with helpful features at transparent pricing.  Northwest Registered Agent stands out with its old fashioned personal service, data security, and registered agent service.

ZenBusiness

Zenbusiess provides a user-friendly interface and an extensive range of services. Although relatively new to the industry, the company has earned a strong reputation for excellence, and it’s difficult to come across negative user reviews about Zenbusiness. Their customers appreciate the streamlined and intuitive UI/UX, which simplifies the formation process. In fact, some LLC members have reported setting up their businesses in less than 30 minutes using the platform. Zenbusiness offers three pricing plans that are transparent and provide excellent value for money. We consider their organizational service to be exceptional, and users can also opt for additional services, such as annual compliance, registered agent, or tax consultations. Even the free service has fantastic features, and the higher tiers offer the added benefit of faster filing (including same-day filing).

Northwest Registered Agent

Northwest Registered Agent has been providing successful services for decades, assisting over three million business owners with their necessary paperwork. As a reliable and competitive player in the market, Northwest is particularly renowned for its top-notch customer service and registered agent service, which shares its name. The company’s customer representatives, known as “Corporate Guides,” guide clients through every step of the process, and the company prides itself on conducting business in a personal, traditional way. You can always expect a human to answer your phone calls, without any chatbots or automated menus. Additionally, the company specializes in efficient and secure registered agent services. However, it’s worth noting that the formation process can take several weeks, so Northwest might not be the best choice if you require urgent assistance.

Final Thoughts

If you have recently taken your sole proprietorship to the next level by forming an LLC, you may be wondering what type of taxes to expect. Now you know that LLCs are almost always taxed as passthrough entities.  Passthrough entities provide tax benefits for the members because they avoid costly double taxation, while also being simple to file.  Members should always remember to claim the business profits properly on their own personal tax documents each year.  For help with annual compliance, registered agent service, and taxation consultations –  many business owners use the services of a third party provider who is an expert.  Today we presented two choices in Zenbusiness and Northwest Registered Agent.  Both these providers stand out for their excellent features, services, and user reviews.  All things considered, passing through taxation benefits are just more reasons why Limited Liability Companies are the entity of choice for so many small business owners.

Frequently Asked Questions (FAQs)