Information About California LLC Taxation
Tax benefits are a major incentive for business owners to establish California LLCs. Since no specific classification exists regarding California LLC taxation, entrepreneurs choosing this business structure have significant flexibility. With the help of your California incorporation lawyer, you can file a sole proprietorship, partnership, or corporation tax return, depending on how you choose to undergo California LLC taxation.
California LLC Default Classification: Pass-Through Taxation
The default mode for California LLC taxation is called pass-through taxation. Pass-through taxation indicates that each member of a California LLC is taxed for profits as an individual. The IRS does not tax LLC profits at the corporate level, and again after they are distributed to members. Instead, members report losses and gains on personal tax returns and pay the IRS any money owed.
Your California LCC is distinct from you, the owner, in that your personal assets are not at risk due to businesses liabilities. However, the LCC is not considered a separate entity from its owner for tax purposes, which allows you to avoid double taxation, in which the profits of a California C – corporation are taxed twice, explained in detail in the section California C – Corporation Taxation.
In some cases, California LLCs are automatically classified as corporations for tax purposes. The qualifications for LLCs which cannot undergo pass-through taxation are complex, and are best explained by an experienced California incorporation lawyer, who can help you understand all of your tax options.
California LLC Taxation: Single Member
Pass-through taxation is the default for single-owner California LLCs. The IRS considers LLCs with one member to be “disregarded entities,” a classification which permits the limited liability company owner to report losses and gains of income through Schedule C of an individual tax return.
If you are the only owner of your California LLC, the entity is called a sole member limited liability company (SMLLC). When you create an LLC with one member, you can choose to be taxed as a corporation, or as a “disregarded entity,” which undergoes the same pass-through taxation as a sole proprietorship. Businesses that are considered “disregarded entities” are viewed as separate from the owner, which is essential to the protection of your assets through a California LLC.
California LLC Taxation: Multiple Members
If your California limited liability company has more than one member, the IRS will view your company as a partnership. Each year, each member of your California LLC will receive Form K – 1, and will report shares, gains, and losses on individual tax returns.
If you have multiple members and are therefore taxed as a partnership, limited liability structure allows you to distribute company gains and losses as profit, deduction, or credit amongst members, as defined by the operating agreement. This is without basing distribution on members’ ownership percentages (this agreement is detailed in the California LLC Operating Agreement section). A limited liability company is the only structure that maintains such flexibility regarding the distribution of gains and losses. However, if you plan to take advantage of California LLC taxation flexibility beyond reaping the benefits of pass-through classification, work with your California incorporation lawyer to avoid violating rules described in Treasury Regulation (26 CFR) 1.704-1.
Generally, California LLCs with multiple members undergo pass-through taxation. However, some California LLCs with multiple members may be subject to double taxation. Talk to your choice-of-incorporation attorney to obtain optimum tax benefits for your California limited liability company.
California LLC Tax Options
Regardless of how many members you may have, you may opt to undergo California LLC taxation as a corporation. If you choose this option, your incorporation lawyer will help you file Form 8832 with the IRS. You may choose whether you wish to be taxed as a California C – corporation, or a California S – corporation. Many small business owners who establish a California limited liability company choose to undergo California LLC taxation as a California S – corporation, which provides tax benefits similar to a California LLC while taking advantage of the structure of a California corporation.
California LLC Election for Corporate Taxation
At a glance, pass-through taxation, undergone by California LLCs and S – corporations, may appear preferable to the double taxation potential faced by corporations. However, even some LLCs may benefit from corporate taxation.
The lowest level of taxation for a California C – corporation is 15 percent. A skilled incorporation lawyer and accountant can help you structure your business to avoid paying over 15 percent in taxes, even if your company grows. Due to pass-through taxation, LLCs and S – corporations are taxed at the individual level, after profits have been distributed to members and shareholders. If your California LLC or S – corporation is highly profitable, you may be paying more taxes as an individual than you would if taxed at the corporate level, even if profits underwent double taxation. For this reason, filing to be taxed as a C – corporation is a smart move by owners of some profitable California LLCs.
Your California incorporation lawyer can help you obtain corporate taxation for a new California LLC by filing Form 8832: Entity Classification Election. Use the same form to change your California LLC taxation classification if you have been previously operating with pass-through taxation.
Filing Tax Returns for California LLC
Since no tax classification exists specifically for California LLCs, the process of filing the correct tax returns for your business can be complex. The unique setup of your California LLC will determine which forms you need to file.
For example, a business undergoing California LLC taxation as a sole proprietorship may be required to submit several varieties of Form 1040, such as Supplemental Income or Loss, or Profit or Loss from Business, or others. You may also be required to file self-employment tax forms if your sole proprietorship generated over $400.
A business undergoing California LLC taxation as a partnership is likely to be required to submit Form 1065: U.S. Return of Partnership Income. This form can be complicated to fill out correctly without the assistance of a California incorporation lawyer and an accountant.
LLCs taxed as corporations will most likely have to file Form 1120: US. Corporation Income Tax Return for C – corporations, or Form 1120S for S – corporations. Again, required data is complicated, errors are easy to make, and proceeding independently is not advised. Work with a California incorporation lawyer and accountant to avoid mistakes that can cost you considerable time and money.