A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in New Jersey, 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 LLC in New Jersey and related aspects.
On this page, you’ll learn about the following:
- Classification of New Jersey LLC Taxes
- LLC Taxes to be Paid in New Jersey
- 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 New Jersey 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. New Jersey 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 New Jersey. These taxes are handled through New Jersey Workforce Commission.
- Franchise Tax Report – In New Jersey, the LLCs do not file a Franchise Tax Report. Because they don’t have any Franchise Tax. Instead, they file an Annual Report with the Secretary of State.
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 New Jersey
An LLC in the state of New Jersey has to pay two main types of taxes to the New Jersey Division of Taxation:
State Income Tax
While representing your LLC in New Jersey, you pay yourself through the earnings you make from the LLC. You’ll be taxed at the New Jersey income tax rate based on your income. The Standard New Jersey State Tax rate for residents and non-residents ranges from 1.4% to 10.7% depending on your earnings. You may also get the opportunity to claim all the standard allowances & deductions upon filing the tax return.
State Sales & Use Tax
The State Sales & Use tax rate in New Jersey is 6.625%. The New Jersey state does not allow any collection of local sales tax further and the Use Tax is paid directly to the New Jersey Division of Taxation. The New Jersey state provides an extensive list of items to be exempted from sales tax.
Corporation Business Tax
New Jersey does not levy a tax on certain businesses for the right to exist as a legal entity and do certain business in the state. However, the state implies Corporation Business Tax, which roughly serves the same purpose. LLCs are exempt from paying the corporation business tax unless they file their taxes as corporations.
Federal Self-Employment Tax
The LLC doesn’t file its own federal return, instead, the members who take out the profit from the LLC must pay the self-employment tax.
The Federal Self-Employment Tax applies to all the earnings of an LLC member. The Federal Self-Employment Tax rate in New Jersey is 15.3%. The members can deduct half of the tax paid from their adjusted gross income.
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, your LLC’s industry, the current income tax bracket that is applicable, deductions applicable, and filing status. One only pays Federal income tax on profits you take out of the business, allowances, and less certain deductions.
In some states, a member has to pay tax on LLC income that exceeds a certain amount. While other states may require the LLC to pay an annual fee.
Employee & Employer Taxes
There are certain payroll taxes that both the employees and the employers pay. The Employee & employer tax implications are different from all the other types mentioned above. All employees of an LLC have to collect and withhold the Payroll tax at the time of receiving the salary. Whether you withhold the Federal Tax or not, each employee has to file an individual Tax return. In New Jersey, all the employers are subject to a 1% tax on their gross payroll.
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. New Jersey 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 New Jersey.
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. A New Jersey 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 New Jersey 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 New Jersey
Any LLC operating in New Jersey is liable to pay 2 kinds of taxes- state taxes as well as federal taxes.
One of the most significant advantages of forming an LLC is the flexible taxation structure it offers. By default, LLCs are considered “pass-through” entities for tax purposes. This means that the LLC itself does not pay taxes; instead, the profits and losses of the business are passed through to the individual members and reported on their personal tax returns. This pass-through taxation is a much simpler setup compared to the double taxation process applied to corporations, where both the company and shareholders are subject to taxation.
However, it is important to note that New Jersey imposes a specific tax, called the “LLC Annual Fee,” on all domestic and foreign LLCs operating within the state. The amount of this fee varies based on the LLC’s gross receipts, providing a graduated scale to ensure that smaller businesses are not overly burdened. It is crucial for LLC owners to carefully monitor their income levels in order to determine the appropriate annual fee they must pay.
In certain cases, an LLC can opt for different tax treatments through a careful election process. For example, the LLC can choose to be taxed as an S-Corporation or a C-Corporation, depending on its specific circumstances and goals. This elected classification, often realized through the IRS Form 8832, can have a profound impact on an LLC’s tax liability, so it is essential that business owners consult with a tax professional to make an informed decision.
Moreover, LLCs with multiple members have an additional layer of complexity when it comes to taxation. In a multi-member LLC, the default tax classification is that of a partnership, with each member reporting their share of the LLC’s income or loss on their individual tax returns. Alternatively, an LLC can choose to be taxed as a corporation, further demonstrating the flexibility inherent to this entity.
Despite these advantages, LLC members should be aware that New Jersey requires LLCs to maintain accurate records of their financial transactions. Any LLC involved in business activities within the state must maintain proper and complete records of their income, expenses, sales, and any other pertinent financial information. These records are essential for filing annual tax returns and complying with governmental regulations, serving as a safeguard for the LLC’s legitimacy.
In conclusion, LLCs in New Jersey benefit from a flexible and straightforward tax structure, predominantly based on pass-through taxation. LLCs generally do not pay taxes at the entity level, avoiding the double taxation faced by corporations. However, it is crucial for LLC owners to be aware of the LLC Annual Fee and the need to make an informed choice when it comes to elected tax classification. By maintaining accurate records and seeking professional advice, LLCs can maximize their tax advantages and enjoy the benefits of this popular business structure in New Jersey.
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.
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.