A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in Pennsylvania, 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 Pennsylvania and related aspects.
On this page, you’ll learn about the following:
- Classification of Pennsylvania LLC Taxes
- LLC Taxes to be Paid in Pennsylvania
- 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 Pennsylvania 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. Pennsylvania 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 Pennsylvania. These taxes are handled through Pennsylvania Workforce Commission.
- Franchise Tax Report – In Pennsylvania, the LLCs do not file a Franchise Report. Because they do not pay Franchise Taxes. The state requires a decennial report from the LLC once every ten years.
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 Pennsylvania
Any LLC must pay the Pennsylvania Tax Commission the following sorts of taxes, according to the Pennsylvania classification of LLC taxes:
State Income Tax
The money earned through your business is subject to State Income Tax. All sorts of business entities carrying out business in the state of Pennsylvania are required to pay Income tax. The current rate of income tax for Pennsylvania is 3.07%.
State Sales and Use Tax
When any LLC indulges in sales, rental, or consumption of tangible products or services, along with digital products, in the state of Pennsylvania, it is liable to pay this tax. The state sales tax rate in Pennsylvania is 6%.
As per the law, if purchases are made from Allegheny County an additional charge of 1% is to be paid. An additional 2% tax is to be paid for purchases from Philadelphia. For information about the items exempted from sales and use tax, visit- Pennsylvania Tax & Revenue Department.
State Franchise Tax
The Franchise Tax is levied in many states, while some have not. It is the fees any LLC owner pays for doing business in the state and existing as a separate entity in the state. Pennsylvania does not levy Franchise Tax on LLCs.
Federal Self-employment Tax
All partners or executives who get earnings from the LLC must pay self-employment tax. This fee is regulated by the Federal Insurance Contributions Act (FICA), which provides Social Security, Medicare, and other benefits. It covers every cent you take out of your firm. The rate of self-employment tax in Pennsylvania is 15.3 percent.
Federal Income Tax
On any earnings from your LLC, you must pay regular federal income tax. This calculation takes into account your income, tax rate, deductions, and filing status.
Only the gains you take out of the company are subject to federal income tax, with various exemptions and deductions. This covers, among other things, tax-free income, company costs, and various healthcare and retirement plan deductions.
Employee and Employer Tax
When you have employees, you have certain employment tax commitments to fulfill and documentation to file. Employers carrying trade in Pennsylvania must deduct Pennsylvania individual income tax from their staff’ salaries, with a few exceptions. At the time of receiving a salary, all LLC staff must collect and withhold the Payroll tax. Your employees may be obliged to submit their own tax forms if you withhold federal and state income taxes.
For the businesses dealing in some special products and services, the below-mentioned taxes are payable to Pennsylvania Tax Commission:
Wine Excise Tax
The PA Liquor Control Board has imposed an excise tax of $2.50 per gallon on direct shipments of wine. Additionally, the sales from these direct shipments in the state of Pennsylvania are applicable for State and Local Sales Tax. For more details, visit- Wine Excise Tax.
Sales or possession of cigarettes in the state of Pennsylvania are subject to Cigarette Tax, a type of excise tax. The current rate of state tax is $2.60 for a pack of 20 cigarettes or $26 for each carton containing 10 packs. For more information, visit- Cigarette Tax.
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. Pennsylvania 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 Pennsylvania.
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 Pennsylvania 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 Pennsylvania 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 Pennsylvania
Any LLC operating in Pennsylvania is liable to pay 2 kinds of taxes- state taxes as well as federal taxes.
LLCs, by nature, are designed to provide owners with limited liability, similar to corporations, while enjoying the flexibility of a partnership. However, their tax treatment differs significantly from corporations. Unlike traditional corporations, LLCs are classified as pass-through entities, meaning they don’t pay taxes at the business level. Instead, the profits and losses of the LLC “pass through” to the individual members, who report them on their personal income tax returns.
In Pennsylvania, the tax obligations of LLCs are relatively straightforward, particularly for those operating as single-member or multi-member LLCs. Single-member LLCs, as the name suggests, consist of only one owner, also known as a member. For tax purposes, by default, Pennsylvania treats single-member LLCs as sole proprietorships. This means that the LLC’s income and expenses are reported on the member’s personal tax return using Schedule C, or if needed, Schedule E, depending on the type of income.
On the other hand, multi-member LLCs in Pennsylvania are classified as partnerships for tax purposes. In such cases, the LLC itself does not pay any taxes. Instead, the LLC must file an informational tax return known as Form PA-20S/PA-65, which provides details of its income, deductions, and distributions to each member. This return allows the Pennsylvania Department of Revenue to assess the taxes owed by individual members based on their share of the LLC’s profits and losses.
The members of a multi-member LLC in the state are required to report their share of the LLC’s income, deductions, and credits on their individual Pennsylvania tax returns using Schedule E, “Rents and Royalty Income (Loss).” Each member’s share is determined by the LLC’s operating agreement or the default proportions set by state law in the absence of an agreement. It’s crucial to maintain accurate records of income, expenses, and allocations to ensure compliance with Pennsylvania’s tax laws.
Furthermore, LLC members may have additional tax obligations at the federal level. If the LLC elects to be treated as a corporation for tax purposes or meets certain Internal Revenue Service (IRS) criteria, it will be required to file a federal tax return using Form 1120, “U.S. Corporation Income Tax Return,” and pay any applicable taxes at the corporate level. However, it is important to consult with a certified tax professional to fully understand the federal tax requirements for LLCs.
In conclusion, understanding how LLCs pay taxes in Pennsylvania is crucial for both current and prospective business owners who choose to operate under this business structure. By grasping the distinction between single-member and multi-member LLCs, owners can determine the reporting obligations they must fulfill and remain compliant with state tax laws. Consulting with a knowledgeable tax advisor can provide clarity and help maximize tax benefits while avoiding potential liabilities associated with improper tax filings.
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.