A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in Massachusetts, 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 a Massachusetts LLC and related aspects.
On this page, you’ll learn about the following:
Classification of Massachusetts 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. Massachusetts 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 Massachusetts. These taxes are handled through Massachusetts Workforce Commission.
- Franchise Tax Report – In Massachusetts, the LLCs file a Franchise Tax Report with the Massachusetts Department of Revenue.
Federal Tax Classifications
When LLCs was 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 Massachusetts
An LLC in the state of Massachusetts has to pay two types of taxes to the Massachusetts Department of Revenue:
State Income Tax
A member of an LLC in Massachusetts 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 Massachusetts State Income Tax rate of 5% 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 Massachusetts levies Sales & use tax on tangible goods & services provided by an LLC. The State Sales & Use tax rate in Massachusetts is 6.25%. However, certain localities or towns may charge additional local sales tax.
Federal Self-Employment Tax
Every member or manager of the Massachusetts LLC earning profit from 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 Massachusetts 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. Massachusetts 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 Taxes
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:
C-Corporation
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.
C-corporation Taxes
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.
S-Corporation
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.
S-corporation 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 Massachusetts.
Liabilities
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.
Taxation
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. A Massachusetts 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 a Massachusetts 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 Massachusetts
Any LLC operating in Massachusetts is liable to pay 2 kinds of taxes- state taxes as well as federal taxes.
One of the key aspects of an LLC structure is its pass-through taxation. This means that the LLC itself is not taxed at the federal level. Instead, the profits and losses “pass through” to the individual members of the company, who then report them on their personal tax returns. This simplifies the overall tax process for LLCs, as they can bypass the double taxation that corporations often face.
Within Massachusetts, LLCs are taxed differently compared to some other states. Here, the state imposes an annual tax on LLCs, which is known as an “annual report fee.” The fee amount varies based on the LLC’s total income for the year. While this may seem like an additional burden to the LLC owners, it is crucial for providing funds to support state services and maintain necessary infrastructure.
Additionally, LLC members in Massachusetts may be subject to personal income tax. As stated earlier, the LLC’s profits and losses pass through to the individual members, consequently becoming a part of their personal taxable income. The state’s income tax rates determine how much each member will owe. These rates vary based on an individual’s total income, with higher earners incurring higher taxes.
Another tax consideration for LLCs in Massachusetts involves state sales tax. If an LLC sells goods or provides taxable services, it will likely need to register for and remit sales tax. The state sales tax rate is currently set at 6.25%, consisting of both a statewide tax and additional local taxes. Properly complying with sales tax laws is crucial to avoid penalties and remain in good legal standing.
Furthermore, LLCs with employees must fulfill their payroll tax responsibilities. This entails paying the necessary federal taxes, such as income tax withholding, Social Security tax, and Medicare tax, along with any state payroll taxes required by Massachusetts. These taxes are paid directly from the LLC’s funds and not the individual members’ personal income.
While tax laws are complex, diligent record keeping is a critical practice for LLCs in Massachusetts. Maintaining detailed financial records, including income, expenses, and tax payments, enables accurate reporting and ensures compliance. LLCs must also complete the relevant tax forms, such as federal Form 1065 and state Form 3, when filing their taxes.
It is crucial for Massachusetts LLCs to consult with professionals well-versed in tax laws to ensure compliance and optimal tax management. Certified public accountants, tax advisors, and business attorneys can provide invaluable guidance regarding state-specific regulations and help optimize individuals’ tax situations while maximizing deductions and credits.
Understanding how LLCs pay taxes in Massachusetts enables LLC owners to navigate the legal and financial realm confidently, proactively managing their business’s future and avoiding any potential pitfalls. By staying informed and seeking expert advice when needed, LLCs can thrive and contribute to both their financial success and the growth of the Massachusetts economy.
FAQ
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.
In Conclusion
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.
