How Is an LLC Taxed?
The answer isn’t so simple, but that’s because Delaware LLC taxation is so flexible! Depending on the internal workings of your business, you may be able to choose from one of several different LLC tax methods.
Delaware LLC Tax Methods
Generally speaking, Delaware LLC tax status can take four different forms.
- Single-Member LLC Taxation
- Partnership Taxation
- C-Corp Taxation
- S-Corp Taxation
By default, an LLC is a "disregarded entity" (Single-Member) or a Partnership, but you have the flexibility to "elect" a corporate tax status. This flexibility is one of the main reasons entrepreneurs choose the Delaware LLC, but it can also create confusion if you’re not familiar with how each option works. The way your LLC is taxed can impact your overall tax liability and the level of administrative requirements you’ll need to manage. By understanding these differences, you can avoid costly mistakes and choose a structure that aligns with your business goals.
Keep in mind that this page is for your general knowledge. When forming an LLC, you should speak to an accountant or tax professional for which tax status is best suited for your business needs.
Single-Member LLC - Disregarded Entity
An LLC with only a single member is automatically classified as a “disregarded entity” by the U.S. Internal Revenue Service, unless it elects C-Corp or S-Corp taxation by filing IRS Form 8832. As a disregarded entity, for purposes of taxation, the LLC is ignored (and does not prepare or file a tax return), and LLC items of gain and loss are treated as those of the sole member directly. Since there is technically no single-member LLC taxation and the LLC does not need to file a tax return with the IRS, any income must be claimed on the single member’s personal tax return as self-employment earnings. This means that the sole owner of the business will need to report all profits and losses alongside their personal income tax return, similar to a sole proprietorship.
A single-member LLC that adds on another member automatically has its LLC tax status adjusted to that of a partnership, which may have tax consequences for the original member. A single-member LLC can also elect C-Corp taxation or, if it meets the eligibility requirements, S-Corp taxation and status.
Partnership Taxation
If your new LLC has more than one member, it will be taxed as a partnership by default if it does not elect to be taxed differently. As the default for LLCs with multiple members, Partnership taxation is the most common form of Delaware LLC taxation. Partnership taxation does not subject the LLC to federal taxation on its income or loss. Instead, each member is allocated their distributive share of the LLC’s income or loss. Each member declares their share on their personal taxes, and pays self-employment tax at their own personal income rate, taking into account the character of the income or loss passed through to the member (owner) (e.g., capital gains taxation rate, etc.).
C-Corp Taxation
Management of an LLC can elect to be taxed under Subchapter C (C-Corp taxation) at the entity level, which is the same way that a corporation is taxed (unless the corporation elects otherwise), by filing IRS Form 8832. A C-Corp is considered a separate entity from its members/owners. Your LLC taxes may be automatically subject to C-Corp taxation if your business is treated as a “publicly-traded partnership” or “PTP” for tax purposes.
An LLC electing C-Corp taxation is subject to what is commonly referred to as “double taxation,” meaning the LLC is taxed on its income and losses at the LLC level, and the members (owners) are also taxed on distributions made by the LLC. These Delaware LLC taxes are based on your income at the then-current corporate tax rate (currently 21%). Unlike in partnership taxation, the character of the LLC’s income is not passed through in distributions from an LLC to its members. Instead, distributions from an LLC electing C-Corp taxation are taxed as ordinary income to the members (owners) or are treated as qualifying dividends (0%, 15%, or 20% depending on the tax bracket of the receiving member) if the distribution qualifies for such treatment.
However, the members (owners) of an LLC electing C-Corp taxation will have many options for reducing the effect of “double taxation.” If taxed as a C-Corp, an LLC in Delaware can deduct all business expenses, interest payments, reasonable salaries paid to owners, employee fringe benefits (such as health and disability insurance), and more, thereby lowering the amount of tax owed. When a Delaware LLC elects C-Corp taxation, they’ll pay lower tax rates on earnings retained for use in improving the company, a benefit that is unique to C-Corp taxation.
In addition, an entity that elects C-Corp for its LLC tax status can fully deduct state and local income tax and property taxes from its taxable income. However, it’s worth keeping in mind that an individual's deductions for state and local income taxes as well as property taxes are capped at $10,000 (or $5,000 for married couples filing separately). Therefore, a member loses the full benefit of this deduction if it invests in a pass-through entity, such as an LLC subject to partnership taxation (or S-Corp taxation, discussed below).
S-Corp Taxation
An LLC can elect to be treated as a pass-through entity by filing Form 2553, electing LLC tax status under Subchapter S (S-Corp taxation). S-Corp taxation is very similar to the LLC default partnership taxation in that, under each, the LLC itself is not taxed as an entity; instead, members are considered employees and can receive a salary subject to payroll taxes. The members take all items of income and loss onto their own tax filings, and the character of the income is passed through from the LLC to the members, preventing double taxation.
Despite the similarities, it's also important to highlight the differences between S-Corp taxation and partnership taxation. In some cases, Delaware LLCs subject to S-Corp taxation can engage in tax planning techniques that an LLC taxed as a partnership cannot. Some of those areas include self-employment taxes and claiming the 20% “qualified business income” deduction available in some cases.
Note that electing S-Corp taxation imposes significant restrictions on the ownership and operations of an LLC. For example, to qualify for S-Corp LLC tax status, an LLC must (1) (a) have no more than 100 beneficial owners, (b) all of whom must be natural persons (no entities, save for certain trusts and estates), (c) that are U.S. persons (no non-US members), and (2) issue only one class of membership interests. These requirements are very restrictive and limit the size and investor base of the LLC significantly.
LLC Tax Comparison Chart
Choosing the right tax treatment can have a big impact on your bottom line. Before deciding how your LLC should be taxed, it helps to see all the options side by side. Below is a simple comparison of the four possible tax treatments and how they differ.
Remember, there is no "perfect" tax status. Instead, try to choose one that aligns with your current revenue and plans for growth. While the default classifications are designed to be easy for beginners, the ability to elect a different status is part of what makes Delaware LLCs so attractive. Still, don't leave your bottom line to chance. Tax laws are nuanced and subject to change, so we recommend consulting with a tax professional or CPA before filing IRS Form 8832 or 2553. Your Delaware tax status can save you thousands in liabilities and double taxation headaches down the road, so take your time choosing the right one.
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