The tax obligations of a limited liability company (LLC) are typically quite simple compared to those of a corporation, but that doesn’t mean everything about LLC taxation is obvious or even straightforward.
One aspect of LLC taxation we get a lot of questions about is the role of the Internal Revenue Service’s Schedule K-1 form. Schedule K-1 is a vital piece of the taxation puzzle for many LLCs, but depending on how your LLC is classified for tax purposes, you may or may not need to worry about the K-1.
Which LLCs need to issue Schedule K-1 forms? What role does this form play in the overall taxation picture for those LLCs? And does the LLC need to file the K-1 with the IRS?
In this article, we’ll answer all of these questions and more, as we run down all the important details of the IRS Schedule K-1.
Which LLCs Need to Issue Schedule K-1?
There are several different ways an LLC can be taxed. Let’s quickly review all of the taxation options an LLC has.
Single-member LLC taxed as a sole proprietorship
The default taxation option for a single-member LLC is very similar to the taxation of a sole proprietorship. All the owner needs to do is claim the net income from their LLC using a form called Schedule C, then transfer that information to a Form 1040 when filing their individual tax return.
In this way, the single-member LLC retains one of the major advantages of a sole proprietorship (the ease with which taxes are paid), while still receiving the biggest benefit of the LLC, which is the limited liability protection it affords its owners.
Multi-member LLC taxed as a partnership
Much like the default option for a single-member LLC is to be taxed like a sole proprietorship, the multi-member LLC’s default option is partnership-style taxes. Like the single-member LLC, the net income passes through the business entity to each owner, who is then responsible for paying their share of taxes to the IRS.
Instead of filing a business tax return, an LLC with more than one member will only submit an informational report called a Form 1065 with the Internal Revenue Service, which describes the total tax burden for the company so that the IRS knows how much to expect from each member.
LLC taxed as a C corporation
An LLC can also be taxed as a C corporation, which means the LLC’s income is subject to what’s known as double taxation. This means that the income is taxed first on the corporate level, and then taxed again when it’s distributed to the LLC’s owners.
It’s not terribly common for an LLC to elect C corporation taxation, because it typically generates more of a tax burden than the other options.
LLC taxed as an S corporation
Finally, an LLC may also elect S corporation taxation, which is very similar to the way a partnership is taxed. The big difference is that LLCs taxed like S corps can classify their owners as employees.
This means that an LLC taxed as an S corp can pay its owners a “reasonable” salary for their positions, and self-employment taxes will only apply to that salary. With partnership-style taxation, all income ends up having self-employment tax attached to it.
The drawback of S corp taxation is that there are many restrictions placed on which businesses can be classified as S corps. For example, they must have fewer than 100 owners, and all of them must be American citizens or residents.
Now, it’s time for the central question of this article. Which taxation styles require Schedule K-1? The answer is that both LLCs taxed as partnerships and LLCs taxed as S corporations need to issue K-1s. But what is the K-1, and why do these types of LLCs require them?
What Is a K-1 and How Is It Issued?
For LLCs taxed as S corps or partnerships (and also for LLCs taxed as sole proprietorships), there is no tax paid by the business itself. Instead, profits pass through the business entity to its owners, who then claim those taxes on their personal returns.
When LLCs with S corp or partnership taxation reach the end of the fiscal year, they need to prepare Form 1065, which is an informational return that indicates the total income for the business. Along with Form 1065, the LLC also submits a filing known as Schedule K, which indicates the income share for the year spread out across all owners.
From there, these LLCs need to distribute Schedule K-1, which is titled “Partner’s Share of Income, Deductions, Credits, etc.” The LLC will need to issue a K-1 form to each owner, and this is the form that indicates how much of the net business income was distributed to that member.
The LLC will submit Schedule K to the IRS along with its Form 1065, but the LLC does not actually file the K-1s. Instead, each owner uses their K-1 to help them file their own personal taxes.
The relationship between a limited liability company taxed as an S corporation or a partnership and its owners requires proper usage of Form 1065, Schedule K, and Schedule K-1 forms. It’s important to note that LLCs taxed as sole proprietorships and C corporations need not worry about K-1s at all.
If you have any further questions about how Schedule K-1, Schedule K, and Form 1065 affect your business, you should contact an accountant or tax attorney.
We hope this article helped you enhance your understanding of how an LLC should issue K-1 forms!