As a business owner, understanding your tax obligations is crucial to maintaining compliance and avoiding potential penalties. For those operating Limited Liability Companies (LLCs) in Tennessee, it's essential to understand your tax classification.
Limited Liability Companies (LLCs) are popular business structures due to their flexibility and the personal liability protection they offer their owners. However, when it comes to taxation, LLCs can be somewhat complex. The Internal Revenue Service (IRS) does not have a specific tax category for LLCs. Instead, the IRS taxes LLCs based on their number of members and whether they choose to be treated as a different type of entity for tax purposes.
By default, single-member LLCs are taxed as sole proprietorships while multi-member LLCs are taxed as partnerships. However, both single-member and multi-member LLCs can choose to be taxed as corporations or S corporations.
Single-Member LLCs
A single-member LLC is an entity with one owner or member. By default, the IRS treats single-member LLCs as "disregarded entities" for tax purposes. This means that the IRS ignores the existence of the LLC and instead treats it like a sole proprietorship.
In this scenario, all profits and losses from the business pass through directly to the owner's personal income tax return. The owner then pays self-employment taxes (Social Security and Medicare taxes) on all net earnings from self-employment.
Multi-Member LLCs
Multi-member LLCs have more than one member or owner. By default, these types of businesses are treated as partnerships by the IRS for tax purposes. Like single-member LLCs taxed as sole proprietorships, multi-member LLCs also enjoy pass-through taxation. This means that the LLC itself does not pay federal income taxes. Instead, each member reports their share of the business's profits and losses on their personal tax return and pays any tax due at their individual tax rates.
Electing Corporate Taxation
Regardless of the number of members, an LLC can choose to be taxed as a corporation or an S corporation by filing a form with the IRS. If an LLC elects to be treated as a corporation, it becomes subject to corporate income tax rates. The business pays taxes on its profits at the corporate level, and then any dividends distributed to members are taxed again at the individual level.
If an LLC elects S corporation status, it still enjoys pass-through taxation like a sole proprietorship or partnership. However, only the portion of income that is considered salary is subject to self-employment taxes. Any remaining income is considered a distribution and is not subject to self-employment taxes.
Business Taxes in TN: What You Need To Know
In addition to federal taxes, your LLC may also be subject to state-level business taxes in TN. Tennessee imposes a franchise tax and an excise tax on most businesses, including LLCs.
The franchise tax is based on either your net worth or your real and tangible property in Tennessee, whichever is greater. The excise tax is based on your net earnings for the year.
