LLCs are responsible for federal income tax
the same way individuals are. Every year, you, as an individual, report
your income to the Internal Revenue Service and pay the associated taxes. Well, LLCs have revenue also that needs to
be reported to the IRS and the associated taxes paid. Now, how that revenue is reported and how
those taxes are paid depends on the structure of the LLC. The rules for reporting and paying taxes come
from the Internal Revenue Code, which is Federal law. This federal law doesn’t exactly follow state
law regarding LLCs. Remember it’s the Texas Business Organizations
Code that allows for LLCs to be legal business entities. So, the IRS doesn’t have rules specific for
how LLCs are taxed. The IRS does have rules for how individual
people are taxed, how partnerships are taxed, and how corporations are taxed. This means that LLCs are either taxed by the
IRS as an individual person, partnerships, or corporations. How do we know which way the LLC is going
to be taxed? By the number of people who are Members of
the LLC. If the LLC only has one member, the IRS taxes
the income from the LLC as the income of that one Member. It’s like the LLC doesn’t even exist and the
income belongs to that one member. This is called a “disregarded entity”. The revenue of the disregarded LLC is reported
on the single member’s personal income tax return. If the LLC has more than one member, the IRS
taxes the LLC income as the income of all the members together, like a partnership. Each member is responsible for paying income
tax on that partner’s share of the revenue. This is called “pass through” taxation. In this case, the LLC does have to prepare
a tax return and a Schedule K-1 for each partner. These are the default rules the IRS follows:
“disregarded entity” for one-member LLCs; and “Pass through” for LLCs with more than
one Member. But remember, I mentioned that the federal
tax rules allow LLCs to be taxed as corporations. Corporations are recognized by the IRS as
their own individual entities. Corporations file their own federal income
tax return and pay the taxes on that income. However, this results in a double taxation,
because, when the Corporation pays a distribution of profits to the owners, like paying a dividend
to shareholders, the owners must report that distribution as their personal income. This is called a double tax, because taxes
are paid twice, once at the corporate level and a second time at the owner or shareholder
level. Small corporations can elect to be treated
as Pass-through entities to avoid this double taxation. When a corporation makes this election, it
is referred to as an “S-Corp”. This Planning Guide is designed to help you
prepare for organizing a new LLC. The Planning Guide is made up of 5 parts. Each part has sections. Each section has an instructional video. These instructional videos start by explaining
the underlying legal concepts for that section. Each video also includes a demonstration for
how to fill out that section of the planning guide. In each demonstration, I’ll show you how I
would use the guide to plan an LLC called “Fake LLC”.