Many business owners establish a limited liability corporation (LLC) when they start.
Usually, it is a single-member LLC, which means you are the only member. We will look at how income taxes – federal, state, and local – are calculated for this form of business.
Federal Income Tax
When it comes to federal income tax, an LLC is a “pass-through entity.” This means that the LLC itself does not pay taxes on business income and does not have to file a return with the IRS. Instead, you, the sole member, pay taxes on the LLC’s profits.
Let’s say you operate your business for the first year and you have made a net profit of $1,000. Congratulations! The $1,000 flows through (several forms, we don’t need to know the details) and becomes part of your adjusted gross income (AGI). AGI, of course, is the sum of all of your income: wages, interest, dividends, capital gains, business income, etc.
It is the starting point to calculate your federal income tax liability.
In addition to federal income tax, you are responsible for paying your federal self-employment taxes: Social Security and Medicare. You pay both the employer taxes and the employee taxes – 15.30% total. (You will deduct half of that elsewhere as an adjustment to income.)
State and Local Income Tax
Similarly, your LLC’s net income is part of your PA taxable income. Same for your local income tax; business net income is taxable.
If your LLC has more than one member, members report a net profit on their returns in proportion to their ownership stake. For a two-member LLC with a 60-40 ownership split, the owners have taxable income of $600 and $400, respectively.
As your business prospers, remember to calculate and pay estimated federal, state, and local taxes. This will avoid a large final tax bill and, potentially, penalties for under-withholding.