Massachusetts LLC Tax Structure – Classification of LLC Taxes To Be Paid

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.

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:

1. 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.
2. 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.
3. 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.
4. 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.

FAQ

How Do LLCs Pay Taxes in Massachusetts

In Massachusetts, LLCs are treated as separate legal entities for tax purposes, similar to corporations. This means that LLCs must file an annual tax return with the state and report their income, deductions, and credits. However, unlike corporations, LLCs are considered pass-through entities, which means that the profits and losses of the business are passed through to the individual members of the LLC. This allows income to be taxed at the individual level rather than at the business level.

The tax treatment of an LLC in Massachusetts can vary depending on whether the LLC is classified as a disregarded entity, partnership, or corporation for federal tax purposes. If the LLC is classified as a disregarded entity, single-member LLCs are treated as sole proprietorships, and profits and losses are reported on the owner’s personal tax return. If the LLC is classified as a partnership, multi-member LLCs are treated as partnerships and must file a partnership tax return. In both cases, income is not taxed at the entity level.

If the LLC elects to be treated as a corporation for federal tax purposes, it must also file a Massachusetts corporate excise tax return. Corporations are subject to a flat 8% tax rate on net income derived from business activities conducted in Massachusetts. In addition, corporations are also required to pay federal income tax on their earnings.

Another important consideration for LLCs in Massachusetts is the annual filing fee that must be paid to the state. All LLCs must file a Form 355A, Annual Report, and pay a $500 filing fee each year to maintain their good standing with the state. Failure to file the annual report can result in the LLC being administratively dissolved by the state.

It is important for LLC owners in Massachusetts to stay informed about their tax obligations to avoid any penalties or fines. Working with a qualified tax professional can help ensure that the LLC is complying with all state and federal tax laws. Additionally, keeping detailed records of income, expenses, and deductions can make the tax filing process smoother and more accurate.

In conclusion, understanding how LLCs pay taxes in Massachusetts is crucial for the financial health of the business. By staying informed about tax obligations and seeking guidance from tax professionals, LLC owners can ensure that their business remains in good standing with the state and federal government. Proper tax planning and compliance can help the LLC thrive and grow in the long run.

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.