A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in North Carolina, 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 North Carolina and related aspects.
On this page, you’ll learn about the following:
- Classification of North Carolina LLC Taxes
- LLC Taxes to be Paid in North Carolina
- 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 North Carolina 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. North Carolina 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 North Carolina. These taxes are handled through North Carolina Workforce Commission.
- Franchise Tax Report – In North Carolina, the LLCs file a Franchise Tax Report with the North Carolina 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 North Carolina
An LLC in the state of North Carolina has to pay two types of taxes to the Secretary of State along with the Federal Taxes. Here are the taxes to be paid in North Carolina,
State Income Tax
In North Carolina, you pay yourself through the earnings you earn from the LLC. These earnings get reflected in your personal Tax return & are calculated at the time of paying the Income Tax. The Standard North Carolina State Tax rate is 5.25%. The state tax rate may vary year to year. You may also get the opportunity to claim all the standard allowances & deductions upon filing the tax return.
Sales and Use Tax
The State Sales and Use tax rate in North Carolina is 4.75%. Other individual municipalities may imply additional sales tax hence the total tax might be higher. The North Carolina Use Tax is slightly more complicated than the other states: The businesses and individuals must pay use tax to the Department when retailers, remote sellers, or facilitators do not have to collect sales or use tax on taxable transactions.
North Carolina levies a tax on certain businesses for the right to exist as a legal entity and do certain business in the state. LLCs are bound to pay the franchise tax under certain circumstances:
If in case an LLC is treated as a C Corporation for federal tax purposes and one of its corporate members has activities in this State additional to its ownership interest in the LLC, then the corporate member is required to file a corporate income and franchise tax return.
Federal Self-Employment Tax
Every member or manager of the North Carolina LLC earning profit out of the LLC has to pay the Federal Self-Employment Tax (which includes 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 North Carolina 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 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.
Employee & Employer Taxes
Any LLC that has employees on the payroll has to pay different kinds of taxes that are applicable 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.
Other Taxes and Duties
According to your industry, you may be liable for certain other taxes and duties. For example, if you’re selling gasoline, you may need to pay a tax on any fuel you sell. Similarly, if you import or export goods, you need to pay certain other duties.
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. North Carolina 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 North Carolina.
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 North Carolina 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 North Carolina 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
|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.
|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
|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.
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 North Carolina
An LLC is a popular option for entrepreneurs because it blends the advantages of a corporation with the flexibility and simplicity of a partnership. One of the key aspects business owners need to consider is how their LLC will be taxed. In the case of North Carolina, the tax requirements for LLCs can be delineated into four key components.
Firstly, it is essential to look at the benefits of a single-member LLC. If your LLC is operated solely by you, it will be treated as a disregarded entity for federal tax purposes. This means that the IRS will not consider your LLC to be a separate entity, but instead, the taxes will be filed as part of your personal income tax return.
Secondly, multi-member LLCs must submit a federal tax return in the form of the partnership tax return, IRS Form 1065. However, it is important to be enlightened about the state-level taxation process as well. While some states impose separate taxes on LLCs, North Carolina does not collect a specific state-level tax on LLCs’ income.
Moving on to the third component, multi-member LLCs in North Carolina still need to submit an annual report, known as Form CD-419, to the Department of the Secretary of State. This report verifies the LLC’s information, including its principal office address and the names of its members. Keep in mind that failing to submit this report timely may result in penalties or administrative dissolution of the LLC.
Finally, discussing the aspect of how LLCs pay taxes necessarily involves mentioning the state and local taxes imposed. North Carolina, like most states, imposes a state income tax on the profits earned by businesses, including LLCs. These taxes are assessed at a flat rate by the North Carolina Department of Revenue. Moreover, LLCs must comply with the state’s sales and use tax requirements, ensuring timely collection and remittance.
While the primary factors regarding how LLCs pay taxes in North Carolina have been discussed here, it is recommended for business owners to consult with tax professionals or accountants for personalized advice. Tax laws can often prove complex, and the nuances of compliance should always be given due attention.
In conclusion, understanding tax requirements is vital for LLC owners who aim to operate in North Carolina. Whether the LLC is a single-member or multi-member entity, comprehending federal and state tax obligations is essential for maintaining compliance and avoiding potential penalties. By being well-informed about the tax structure, LLC owners can focus on developing and growing their businesses within the confines of the legal framework.
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.