A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in Illinois, we know that it is a pass-through taxation structure. Typically, the profit LLC makes passes through the LLC to its members. Based on the profit share, members file their income tax returns. LLCs, unlike other corporations, do not have to pay income taxes based on profit or revenue.
IRS (Internal Revenue Service) allows LLCs to choose their preferable classification of tax at the beginning of the LLC formation. In general, a single-member LLC is taxed as a sole proprietor and a multi-member LLC is taxed as a partnership. As there is no fixed tax structure for LLCs, anyone certainly wants to opt for the most beneficial one. Keep reading till the end to know more about the tax structure of an Illinois LLC and related aspects.
On this page, you’ll learn about the following:
- Classification of Illinois LLC Taxes
- LLC Taxes to be Paid in Illinois
- Default LLC Tax Classification Rules
- Options to Change Default Tax Classification
- Choosing a Classification for Your LLC
- Classification of LLC Taxes – At a Glance
Classification of Illinois LLC Taxes
An LLC is considered a Pass-through Entity because it allows the income to pass through & become self-employment income. The members of the LLC have to pay Self-employment tax or Self-Employment Taxes on any income they earn through the LLC. The LLC has to pay Franchise Tax on its income. In addition to the Self-employment tax, there are some other requirements that an LLC has to consider, such as:
- Franchise Tax – Franchise tax applies to or levies upon LLCs, C-corporations, & S-corporations. Sole Proprietorship & Partnerships (directly owned by individuals) are exempted from the Franchise Tax. This tax is to be paid with the office of the Comptroller of Public Accounts.
- Federal Tax Identification Number – An LLC with employees must obtain a Federal Tax Identification Number. Illinois does not have a separate State Tax Identification number.
- State Employer Taxes – If an LLC has employees on the payroll, it must pay state employer taxes in Illinois. These taxes are handled through Illinois Workforce Commission.
- Franchise Tax Report – In Illinois, the LLCs file a Franchise Tax Report with the Illinois Department of Revenue.
Federal Tax Classifications
When LLCs were recognized as one of the types of Business Corporations, IRS did not create a new tax classification just for the LLC. LLCs were allowed to choose from the current tax classifications.
LLC Taxes to be Paid in Illinois
An LLC in the state of Illinois has to pay three types of taxes to the Illinois Department of Revenue:
State Income Tax
An LLC member in Illinois has to pay himself through the earnings. These earnings get reflected in your personal Tax return & are calculated at the time of paying the Income Tax. The Standard Illinois State Tax rate of 4.95% is applicable to your earnings. You get the opportunity to claim all the standard allowances & deductions upon filing the tax return.
State Sales & Use Tax
The state of Illinois levies Sales & use tax on tangible goods & services provided by an LLC. The State Sales & Use tax rate in Illinois is 6.25%.
Illinois used to have a Franchise Tax, which was levied on all the businesses for the privilege of having a franchise or active business in Illinois. However, Illinois State has started to repeal this tax in phases from the year 2021.
Federal Self-Employment Tax
Every member or manager of the Illinois LLC earning profit out of the LLC has to pay the Federal Self-Employment Tax (also called the Social Security or Medicare Tax). The Federal Self-Employment Tax applies to all the earnings of an LLC member or manager. The Federal Self-Employment Tax rate in Illinois is 15.3%. To deduct your LLC’s expenses from the income earned, you must calculate the Self-Employment Tax your LLC owes.
Federal Income Tax
Like State Income Tax, this tax also applies to the earnings you make in your LLC. The Federal Income Tax Rate is subject to the earnings you make, the type of your LLC’s industry, the LLC tax bracket applicable, deductions applicable, etc.
Employee & Employer Taxes
Any LLC with employees on the payroll has to pay different kinds of taxes that apply to all the employees. The Employee & employer tax implications are different from all the other types mentioned above. For Example, All employees of an LLC have to collect and withhold the Payroll tax at the time of receiving the salary. Irrespective of whether you withhold the Federal Tax or not, each employee has to file an individual Tax return.
Default LLC Tax Classification Rules
By default, the LLCs are categorized as below (In both the categories, separate filing of income is not required):
Disregarded Entity (Single-Member LLC)
A single-member LLC is usually disregarded from the taxes. Hence a single-member LLC is also called a disregarded entity. Under the U.S. tax law, it is assumed that a single-member LLC is owned by an individual (& not by another LLC), so the U.S. tax law levies rules on it as a Sole Proprietor. Single-member LLC’s owner (Sole Proprietor) has to report all the income of the LLC via his own income tax return.
Sole Proprietorship Taxes
As mentioned earlier, the single owner of the LLC is treated as the Sole proprietor of the LLC & has to file the Self-Employment Tax on all of the LLC’s earnings. Illinois does not levy State Income Tax, so a single-member LLC must file only the Federal Income Tax.
Partnership (Multi-Member LLC)
Any LLC with more than one owner is referred to as Multi- Member LLC & it is taxed as a partnership by default. Similar to the Single Owner or Single Member LLC, this LLC is also a pass-through entity. This means that the income of the LLC passes through the income of the members & they have to file taxes through their own earnings.
Partnership or Multi-Member LLC has to pay taxes similar to the Single Member LLC. If the Partnership LLC is directly owned by individuals, it is exempted from the Franchise Tax. All the members of the Multi-Member LLC are liable to pay Self-Employment Tax & Federal Income Tax.
Options to Change Default Tax Classification
The LLCs are categorized either as sole proprietorships or as partnerships, depending on the number of members the LLC has. This is the default tax classification applicable to LLCs. However, the LLCs have an option of changing the default classification & opting to register under the following categories for taxation purposes:
An LLC can prefer to be treated as a C-corporation by filing form 8832 (the Entity Classification Election Form) with the IRS. The C-corporation is a regular corporation that is subject to corporate taxes & it is not a pass-through entity.
An LLC taxed as a C-Corporation is not a pass-through entity. In a C-corporation, the members/shareholders/ owners are taxed separately. The shareholders of the C-corporation are taxed twice on the dividends that they earn. The dividends of the shareholders are taxed at the corporate level – with a Corporate Tax filed with Form 1120 & at a Shareholder level – an Income Tax filed with Form 1040. Shareholders are subjected to Federal Income Tax.
The S-Corporation is the most common type of corporate structure used by small businesses. It was created to provide corporations with limited liability protection while maintaining the benefits of being a separate legal entity. An LLC can prefer to be treated as S-Corporation by filing Form 2553. S-corporations are small business corporations, that choose to pass through the corporate income, losses, deductions, & credits to the shareholders for the purposes of Federal Taxes.
An S-Corporation is similar to an LLC except that it is treated by the IRS as a corporation for tax purposes. S-Corps do pay corporate income taxes; however, they are still considered disregarded entities for federal tax purposes.
Like an LLC, an S-Corp reports its annual earnings on a separate Schedule E on the member’s personal account. An S-Corp is treated by the IRS much like a partnership for tax purposes. Unlike Partnership, in S Corporation, the shareholders are required to pay Federal Self Income tax on their share of the company’s profits.
Choosing a Classification for Your LLC
In terms of owners’ protection against liability, perpetual existence, & savings in Taxation, Both LLCs (Limited Liability Companies) & Corporations are very much alike. However, with regard to formalities, Taxation, & capital, LLCs & Corporations differ in Illinois.
Both LLCs and Corporations provide liability protection to their owners. The LLC provides protection against inside liability (towards the employee) & outside liability (towards the creditor). The Corporation usually provides only the inside liability.
Tax Classification Flexibility
For taxation purposes, an LLC has a choice of being treated as a sole proprietorship, Partnership or C-corporation or S-corporation. A corporation can choose to be treated only as C or S Corporation.
As mentioned earlier, the LLC can choose to be treated as a corporation; the Corporation does not have the option of being treated as the LLC. An Illinois LLC is subjected to Franchise tax, Federal Income Tax, Sales & Use Taxes & State Employment Taxes (for LLCs that have employees)
A regular corporation or a C- Corporation is subjected to corporate tax, which can be filed through Form 1120 every year. The shareholders have to pay the Income-tax, only when they receive dividends from the Corporation. These dividends are taxed twice at the corporate level (on a corporate form)& at the shareholder level (on shareholder form).
An S- Corporation in LLC is not subjected to corporate taxes. But the shareholders are subjected to Taxation – even if they do not receive any dividends. A member of an Illinois S-corporation has to pay Federal Self employment Tax only on his salary; any other profits that he makes through the LLC are not subject to the 15.3% Self Employment Tax.
Classification of LLC Taxes – At a Glance
|Points of Difference||LLC||S- Corporation||C-Corporation||Sole Proprietorship|
|Taxation||As an LLC, by default, there is no tax levied at the entity level. The members’ income or even the loss is passed through to members or owners.||Similar to LLC, no tax is levied on an S-Corporation at the entity level. The members’ income or even the loss is passed through to members or owners.||The C-Corporation is often taxed at the entity level. The Dividends are taxed at the shareholders’ level.||The Sole- proprietorship as an entity is not taxable. The Sole Proprietor pays taxes as an Individual.|
|Double Taxation||The LLC does not have Double Taxation||There is no Double Taxation in S-Corporation||There is Double Taxation in C-Corporation, only when the Shareholders earn in the form of dividends.||No Double Taxation in a sole proprietorship.|
|Self Employment Tax||The net income of the members or owners is subject to self-employment tax.||The salaries of the shareholder are subject to self-employment tax, but any other profits that the shareholder makes are not subject to the employment tax.||The C-Corporation is subject to self-employment tax.||The Sole-proprietorship is subject to self-employment tax|
|Pass-Through Income/Loss||An LLC is often referred to as a Pass-through entity because its income passes through/ passes to its members.||Yes, An S Corporation is a Pass-through Entity.||No, A C-Corporation is not a Pass-through Entity.||Yes, A Sole-proprietorship is a Pass-through Entity.|
How Do LLCs Pay Taxes in Illinois
Any LLC operating in Illinois is liable to pay 2 kinds of taxes- state taxes as well as federal taxes.
When it comes to taxation, one of the key benefits of forming an LLC is that the company itself is usually not subject to federal income taxes. Instead, the LLC’s income is passed through to its members or owners, who report their share of income on their individual tax returns. This feature, known as “pass-through taxation,” helps to eliminate the issue of double taxation that often arises with traditional corporations. It allows LLC owners to only pay taxes at the individual level, aligning with their personal tax rates.
In Illinois, LLCs are subject to both state and federal taxes, although the state adopts a considerably more straightforward and favorable approach. For federal purposes, the IRS treats an LLC as either a sole proprietorship (if it has one owner) or a partnership (if it has multiple members). Consequently, the LLC’s income is reported on the owner’s personal tax return using either a Schedule C or Schedule E form, respectively.
Illinois, like most states, follows federal classification rules for LLC taxes. However, it offers an advantage in terms of the state tax rate. Individual income tax rates in Illinois range from a flat rate of 4.95% to 7.99% for taxable income. Since LLC owners are responsible for reporting their share of the income on their personal tax returns, they are subject to these income tax rates at the individual level. This means that taxation is progressive, with higher-income individuals paying a higher tax rate, a system aimed at promoting fairness and ensuring everyone contributes their fair share.
Another significant aspect to consider when it comes to LLC taxation in Illinois is the possibility of paying the state’s franchise tax or filing an annual report. However, it is important to note that the state had repealed its franchise tax in 2019, granting a reprieve for new LLCs formed thereafter. While existing LLCs are still required to file an annual report, relief can be found in the measure of the annual filing fee, which has decreased over the years, placing less of a financial burden on entities.
Overall, understanding the tax implications for an LLC operating in Illinois can help owners make informed decisions about their businesses. By adopting a pass-through tax structure, LLCs can avoid the burden of entity-level taxation in both state and federal terms, providing significant financial benefits to their owners. The progressive income tax system in Illinois ensures that the tax burden aligns with individuals’ income levels, promoting an equitable approach to taxation. It is also heartening to see that the state of Illinois has taken steps to alleviate financial pressures for businesses by repealing the franchise tax for new LLCs and reducing the annual filing fees.
In conclusion, navigating the tax landscape for LLCs in Illinois might seem daunting but understanding the basics is crucial for LLC owners to comply with their tax obligations and maximize the benefits of this business structure. Although seeking professional advice in intricate taxation matters is always advisable, having this fundamental knowledge sets a strong foundation for a successful business venture.
C-Corporation. It taxes the dividends of the shareholders at the corporate level as well as at an individual level.
An LLC is often referred to as the pass-through entity because the income or the assets pass through the members or owners of the LLC.
The LLCs have two default classifications. It can be termed as a single-member LLC or a multi-member LLC.
When choosing a different classification for taxation, it is essential to understand the liabilities & taxes applicable in that classification.
How Do LLCs Pay Taxes in Illinois
LLCs in Illinois enjoy certain advantages when it comes to taxes. Unlike C-corporations, where income is taxed both at the corporate level and again at the individual level when distributed as dividends, LLCs follow a pass-through tax structure. This means that the LLC itself does not pay taxes on its income. Instead, the profits and losses of the LLC are “passed through” to the owners or members, who report them on their personal tax returns.
The pass-through taxation model of LLCs can provide significant tax savings to its members. It allows them to avoid the double taxation imposed on C-corporations, where dividends are taxed at both the corporate and individual level. Instead, LLC members only pay taxes once, at their individual income tax rates. This is often seen as a major advantage as it generally results in a lower tax burden for the owners.
However, it is important to comprehend the specific rules and requirements that LLCs must meet in Illinois to properly fulfill their tax obligations. Firstly, LLCs in Illinois are required to file an annual Form IL-1065, also known as the Partnership or S Corporation Replacement Tax Return. This return provides detailed information about the LLC’s business activities, income, deductions, and distributions. It allows the Illinois Department of Revenue to verify the validity of the pass-through method and ensure compliance with tax laws.
Furthermore, LLCs with multiple members must also complete Schedule K-1 for each member. Schedule K-1 outlines each member’s share of the business’s profits, losses, deductions, and credits. It is crucial that LLCs accurately prepare and provide this information to ensure consistency in payment and receipt of taxes for both the business and the individual members.
Additionally, it is important for LLCs to consider the potential Illinois Franchise Tax implications. Unlike income tax, this is assessed on a per-member basis rather than the entity as a whole. Every member of the LLC is required to pay an annual Franchise Tax fee. If the LLC fails to make the necessary payment, penalties and interest may be levied.
Navigating the tax requirements of an LLC in Illinois can be intricate and the consequences for non-compliance can be detrimental. It is recommended that LLC owners seek the advice of qualified professionals, such as accountants or tax attorneys, who can help them understand, meet, and fulfill their obligations effectively. Additionally, remaining informed about any changes or updates to Illinois tax laws and regulations is crucial to avoid being caught unaware and potentially facing penalties.
In conclusion, understanding how LLCs pay taxes in Illinois is vital for business owners aiming to maintain compliance with tax laws while maximizing tax benefits. By correctly following the pass-through tax structure, timely filing the required tax returns, and adhering to the necessary payment schedules, LLCs can efficiently navigate their tax obligations in Illinois and focus on growing their businesses in a financially responsible manner.
Every Tax classification has its own set of benefits & restrictions. Every state will have different taxation rules for each of the categories of business corporations. Depending on the objective of formation of the business entity (Eg. To avoid dual Taxation- one can choose S Corporation, for more flexibility, one can choose the LLC format). It is essential to understand the taxing structure of each country & each Classification; to decide how you wish to treat your LLC.