A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in Texas, 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 Texas and related aspects.
On this page, you’ll learn about the following:
- Classification of Texas LLC Taxes
- LLC Taxes to be Paid in Texas
- Default LLC Tax Classification Rules
- Options to Change Default Tax Classification
- Choosing a Tax Classification for Your LLC
- Classification of LLC Taxes – At a Glance
Classification of Texas 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. Texas 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 Texas. These taxes are handled through Texas Workforce Commission.
- Franchise Tax Report – In Texas, the LLCs do not file an annual report with the secretary of state; instead, it is submitted in the form of a Franchise Tax Report with the Texas Comptroller of Public Accounts
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 Texas
For any LLC registered in the state of Texas, it is required to pay state as well as federal taxes, based on the Texas classification of LLC taxes. Subtypes of both of these taxes are listed below:
State Income Tax
Texas is on the list of states that do not impose any income tax. There are 9 states in total that are free from state income taxes.
State Sales & Use Tax
Sales & use tax is payable by the LLCs working in the state of Texas. This tax is levied on the sale, leasing, and rental of physical products and services within the state boundaries of Texas. This tax is charged at the rate of 6.25% state-wide. Although, some counties may levy an additional 2% sales and use tax, accounting for a total of 8.25%.
State Franchise Tax
The Texas franchise tax is a privilege tax levied on all taxable entities founded, organized, or doing business in Texas. The amount of revenue your business makes, as well as a few other factors, determine the Texas franchise tax rate. In fact, if your revenue falls below a specific threshold, you will not be required to pay any franchise tax.
Federal Self-employment Tax
The Federal Self-Employment Tax must be paid by any profit holder or management of a Texas LLC that makes a profit. The federal self-employment tax applies to each member’s or management’s profits. Texas’ federal self-employment tax is 15.3 percent.
Federal Income Tax
The profits you make in your LLC are subject to federal income tax. Your federal income tax rate is determined by your earnings, the industry in which your LLC works, the appropriate LLC tax bracket, reductions, and other factors.
Employer and Employee Tax
Any LLC with employees is required to pay a variety of taxes that are relevant to all employees. Employers doing business in Texas are liable for deducting Texas Personal income tax from their employees’ compensation, with a few exceptions. When receiving a salary, all LLC employees must collect and withhold the Payroll tax. Your employees may need to submit their own tax forms, regardless of whether or not you withheld the federal and state income taxes.
There may be additional taxes to pay depending on the type of items or services your company provides. The following are a few of them:
Cement Production Tax
Anyone who manufactures cement in Texas or transports cement into Texas distributes or sells cement in intrastate commerce, or uses cement in Texas is subject to this tax. The tax is dependent on how much cement a person distributes, sells, or uses for the very first time in intrastate trade, and it only applies to one distribution, sale, or use of cement.
Oyster Sales Tax
The fee must be paid by the first authorized shellfish merchant who purchases, harvests, stores, handles, packs, labels, unloads at dockside, or keeps oysters harvested from Texas waters.
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. Texas 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 Tax 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 Texas.
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 Texas 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 Texas 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 Texas
Starting and running a business can be overwhelming, and dealing with taxes is often one of the most challenging tasks for business owners. In Texas, limited liability companies (LLCs) enjoy certain advantages when it comes to taxation. Understanding how taxes work for LLCs in the Lone Star State is essential to ensure compliance with government regulations and to maximize the benefits of this business structure.
Unlike corporations, LLCs are not considered separate tax entities under federal law. Instead, the Internal Revenue Service (IRS) views them as “pass-through” entities. What this means is that LLCs but not file income taxes as a business entity, LLC owners, or members, will report their share of income and losses on their individual tax returns.
When it comes to taxation regulations, Texas follows the federal government’s approach. This means that LLCs in Texas are treated in the same manner for federal and state taxation purposes. The lack of a state income tax in Texas works to the advantage of LLCs. While businesses operating in states with income tax are often subject to double taxation (taxation at both the corporate and individual level), that is not the case for LLCs in Texas.
Upon formation, an LLC is typically required to obtain an Employer Identification Number (EIN) from the IRS. This number is used for various purposes, such as filing taxes and opening a business bank account. In Texas, there are no specific income tax forms designed exclusively for LLCs. Instead, LLC owners must determine the proper tax forms based on their intended tax classification.
LLCs have the flexibility to choose how they are taxed. By default, single-member LLCs are treated as disregarded entities, and the income and losses of the business are reported on the member’s individual tax return using Schedule C. On the other hand, multi-member LLCs are treated as partnerships for tax purposes, and each member must report their share of the income and losses on their individual tax returns using Schedule K-1.
Although LLCs default to being disregarded or classified as partnerships, LLC members also have the option to elect corporate tax treatment. This can be beneficial to LLCs that prefer to retain earnings within the business rather than distribute them to the members immediately. By choosing corporate tax treatment, LLCs will be subject to federal corporate income tax on their profits, and any dividends distributed to members will be taxed as personal income.
Additionally, Texas imposes a franchise tax on businesses, including LLCs that elect corporate tax treatment. The franchise tax is levied based on a business’s total revenue or its “margin” if the total revenue exceeds certain thresholds. It’s important to note that single-member LLCs are not subject to the franchise tax.
Understanding the different tax options and requirements for LLCs in Texas is crucial for entrepreneurs and small business owners. Consulting with a tax professional or an attorney experienced in business taxation matters is highly recommended to ensure compliance with federal and state regulations.
In conclusion, LLCs have the advantage of being pass-through entities in Texas, which helps avoid double taxation. LLC owners report their share of income and losses on their individual tax returns. Understanding the various tax options and consulting with professionals will enable business owners to optimize the tax benefits and stay in good standing with the state and federal tax agencies.
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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.