55% of Americans believe that they are able to start their own business. What not every aspiring entrepreneur realizes is that starting a business comes with a lot of research and technical steps.
For one, you have to choose a business entity when you register your business. Business entities can affect how you pay your taxes. Two common options are LLCs and corporations.
Keep reading to learn the differences between LLC vs. corporation taxes.
How Do LLC Taxes Work?
An LLC (limited liability company) is treated as a pass-through entity for federal income tax. This means that the LLC won’t pay taxes on the business income itself. Instead, members of the LLC pay taxes on their share of the LLC’s profit.
State and local governments can levy additional LLC taxes as well.
As the owner, you have the ability to choose how you want to pay LLC taxes. If you don’t want your LLC to be a pass-through entity, you can choose that it be taxed as a corporation.
There are different types of LLC taxes that LLC members are responsible for paying. Members must pay income tax, self-employment tax, payroll tax, and sales tax.
Single-member LLCs are disregarded entities for federal income tax purposes by default. This means that the LLC doesn’t have to file separate income taxes to report expenses and income.
Expenses and income will come from the member’s tax return. As the sole owner, you would report business expenses and income on Form 1040, Schedule C.
Multi-member LLCs treated as pass-through entities for federal income tax purposes work similarly to single-member LLCs. Each member will pay taxes on their income.
For example, if two members in an LLC split ownership in half, each owner is responsible for paying taxes on 50% of the company’s profit. Owners can claim half of the deductions in this case as well.
LLC members aren’t considered employees, but they still owe social security and Medicare taxes to the IRS. To pay these taxes, they will use a Schedule SE form.
Attach this form to your tax return when you file it. Owners can use the form to calculate tax liability.
Not all LLCs have employees, but those that do must collect and pay payroll taxes, such as:
- Medicare taxes
- Social Security taxes
- Unemployment taxes
Owners can file payroll taxes using IRS Form 940 and Form 941. Form 940 gets filed each year to report unemployment tax obligations and Form 941 gets filed on a quarterly basis. The latter form reports withheld income taxes.
LLCs that sell taxable goods or services need to collect sales tax from customers. If you have a physical shop in a state that imposes a sales tax, you must pay it.
Online businesses might be responsible for collecting sales taxes in the state to which they ship goods.
How Do Corporation Taxes Work?
Corporations are legal entities separate from their owners. These entities are taxed on profits on non-deductible expenses.
Taxable profits are money kept in the company to cover expenses, also known as retained earnings. They are also profits distributed to shareholders as dividends.
Corporations can reduce taxable profits by deducting many business expenses. Money that the corporation spends in pursuit of profit can be deducted. For example, corporations can deduct these expenses:
- Startup costs
- Operating costs
- Product and advertising outlays
- Salaries and bonuses
- Medical and retirement plans
Talk with a tax advisor to ensure you don’t miss out on important tax deductions if you have a corporation.
Corporate Tax Payments
A corporation can prepare for tax planning by filing a corporate tax return with IRS Form 1120. You’ll pay taxes at a corporate income tax rate on corporation profits.
Corporations that owe taxes should estimate how much they will owe at the end of the year and then make quarterly payments on that amount.
Shareholder Tax Payments
If the owners of the corporation are employees of the corporations, they pay individual income taxes on their salaries and bonuses, much like regular employees of any other company.
Salaries and bonuses are deductible so a corporation won’t have to pay taxes on them.
Corporations that distribute dividends to owners have to report and pay personal income on the dividend amounts. Dividends are not tax-deductible so the corporation has to pay taxes on them.
Dividends get taxed twice, once for the corporation and then again for the shareholders. Small corporations don’t typically run into this problem because their owners are employees with salaries and bonuses.
S Corporation Taxes
By default, corporations are C corporations and are taxed as such. Some corporations avoid double taxation of dividends by electing S corporation status.
S corp taxes work similarly to LLC taxes. All profits and losses of the corporation pass through the business and get reported on the owners’ personal income tax return.
Corporations with 100 or fewer shareholders, and those that meet additional ownership requirements, might be eligible for S corporation taxation.
LLC vs. Corporation Taxes: The Breakdown
Unlike corporations, LLCs don’t have an IRS tax classification of their own. Single-member LLCs are taxed as sole proprietorships and multi-member LLCs work like partnerships.
No matter the case, company profits pass through to the owners who pay income and self-employment taxes on their share of the business.
However, an LLC can elect to be taxed as a C corporation. In some cases, if they qualify, they can be taxed as an S corporation. This can make LLC vs. corporation taxes a complicated topic.
Corporations can be either taxed as C corporations, the default method, or S corporations. S corporations don’t pay corporate income tax and can avoid the double taxation that comes with offering dividends to shareholders.
Understanding Business Taxes
Taxation is a complicated topic that has a lot of influence on the business entity that you choose. When it comes to LLC vs. corporation, there are a lot of differences, but some similarities.
LLCs can choose to be taxed as corporations and corporations can avoid double taxation by becoming an S corporation.
To get a better understanding of business taxes and which entity you should choose, schedule a free consultation with a tax planning expert.