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


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A limited liability company in general does not have to pay any business taxes. When we talk about the classification of LLC taxes in Washington State, 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 Washington State LLC and related aspects.

Classification of Washington State 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. Washington State 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 Washington State. These taxes are handled through Washington State Workforce Commission.
  4. Franchise Tax Report – In Washington State, the LLCs do not pay any Franchise Tax or file a Franchise Tax Report,

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 Washington

Any LLC operating business within the state boundaries of Washington is required to pay the following types of taxes, based on the Washington classification of LLC taxes:

State Income Tax

Washington is one of nine states that does not have an income tax.

State Retail Sales Tax

In general, retail sales tax applies to all sales of merchandise to consumers. Certain services, such as payments by abstract, title insurance, escrow, and credit bureau firms, including tenant screening services, are subject to retail sales tax. Retail sales tax must be collected by sellers. If no retail sales tax has been collected, the in-state consumer must pay use tax. The current retail sales tax rate in Washington is 6.5 percent, although it may differ based on your location, county, or city.

State Use Tax

Use tax is applied when the items are first used in Washington. It is based on the purchase price of the products and includes any freight, delivery, or shipping fees paid to the vendor. The rates are identical to those of the retail sales tax.

State Business & Occupation Tax

The state business and occupation (B&O) tax apply to almost all firms in Washington. This covers nonprofit and for-profit firms organized as corporations, limited liability companies (LLCs), partnerships, and sole proprietorships. The B&O tax is based on gross income from commercial activity. It is charged at the rate of 1.5% of gross receipts.

Federal Self-employment Tax

The Federal Self-Employment Tax is payable by each member or administrator of an LLC based in the state of Washington who earns a profit. Each partner’s or manager’s profits are subject to the federal self-employment tax. Washington has a 15.3% federal self-employment tax. You can calculate the Self-Employment Tax your LLC owes in order to deduct your LLC’s expenses from the money earned.

Federal Income Tax

Federal income tax is paid on all sorts of earnings made from your LLC. It is based on your income, rate at which you are taxed, reductions, 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 salary, company costs, and various medicare and retirement plan exemptions.

Employer & Employee Tax

Any LLC with working staff on the payroll is required to pay a variety of taxes that apply to all employees. Employee and employer tax effects are distinct from those of the other types. For example, at the time of receiving a payout, all working staff of an LLC must collect and withhold the Payroll tax. Whether you have withheld the federal tax or not, each employee is required to file a separate 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. Washington State 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 Washington State.

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 Washington State 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 Washington 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 LLCS- CorporationC-CorporationSole Proprietorship
TaxationAs 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 TaxationThe LLC does not have Double TaxationThere 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 TaxThe 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/LossAn 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

Which Type of Corporation has double taxation?

C-Corporation. It taxes the dividends of the shareholders at the corporate level as well as at an individual level.

Why is an LLC called a pass-through business entity?

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.

What is the default classification of the LLC?

The LLCs have two default classifications. It can be termed as a single-member LLC or a multi-member LLC.

What should be taken into consideration while changing the default classification of the 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 Washington

LLCs are a favorable choice for many entrepreneurs due to their tax flexibility. Unlike corporations, LLCs are not treated as separate taxable entities by the federal government. Instead, they are considered pass-through entities, meaning that the company’s profits and losses flow through to the owners’ personal tax returns.

This taxation method has significant advantages. It eliminates the issue of double taxation that corporations face, where the company’s profits are taxed at both the corporate level and the individual level when distributed to shareholders as dividends. For LLCs, the owners only need to report the earnings and losses from the company once on their personal income tax returns.

The pass-through taxation structure of LLCs in Washington allows them to take advantage of personal tax rates provided by the state. These rates tend to be more favorable compared to corporate tax rates, especially for businesses with lower net incomes or startup phases.

Additionally, LLC owners have the flexibility to choose how they want to be taxed. By default, LLCs in Washington are classified as “disregarded entities” for tax purposes. This means that single-member LLCs are disregarded altogether, while multiple-member LLCs are treated as partnerships. In both cases, the income and expenses of the LLC flow directly to the personal tax returns of the owners.

However, LLC owners can also elect to be classified as an S-corporation for tax purposes, commonly known as an S-Corp. By opting for this tax treatment, the LLC’s profits, losses, deductions, and credits are reflected on a separate tax return specifically designated for an S-Corp. This choice offers potential tax advantages by allowing the owners to receive both a salary and distributions, allowing for potential savings on self-employment taxes.

In Washington, LLC owners are also required to pay Business & Occupation (B&O) tax based on their gross revenue. This tax is applicable to all types of businesses operating in the state and commonly ranges from 0.471% to 2%. However, certain exemptions and deductions exist, particularly for businesses with lower revenues. It is important for LLC owners to be aware of these provisions to optimize their tax obligations and leverage possible deductions.

Navigating the intricate tax requirements for LLCs in Washington can be complex, and it is recommended that business owners consult with tax professionals or legal advisors specializing in small businesses or LLCs. These experts can provide personalized guidance and utilize their knowledge and expertise to ensure compliance with the state’s tax laws while maximizing the benefits available within this taxation structure.

It is evident that understanding how LLCs pay taxes in Washington is crucial for entrepreneurs and small business owners. The ability to choose between different tax classifications offers flexibility and potential advantages. With the climate fostering entrepreneurship and investments, LLCs continue to play an instrumental role in Washington state’s economy. By encouraging tax-friendly environments for LLCs, the state stimulates business growth, job creation, and economic prosperity as a whole.

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.


About Author & Editorial Staff

Steve Goldstein, founder of LLCBuddy, is a specialist in corporate formations, dedicated to guiding entrepreneurs and small business owners through the LLC process. LLCBuddy provides a wealth of streamlined resources such as guides, articles, and FAQs, making LLC establishment seamless. The diligent editorial staff makes sure content is accurate, up-to-date information on topics like state-specific requirements, registered agents, and compliance. Steve's enthusiasm for entrepreneurship makes LLCBuddy an essential and trustworthy resource for launching and running an LLC.

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