A limited liability company usually doesn't pay taxes directly, itself, to the IRS come tax time. Instead, the company divides profits among the owners, each of whom pays tax on his share of the proceeds as personal income. An owner's K-1 form shows his LLC income for the year, like a W-2 does for a salaried position and makes reporting LLC income easier.
LLCs and Taxes
The owners of an LLC can choose to have the IRS treat the company as a corporation, a partnership or a disregarded entity:
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- As a partnership, profits are allotted among the members at the end of each year. Those profits are taxable income. Owners receive a K-1 showing their share.
- If the owners choose to treat the company as an S corporation, owners receive a K-1.
- As a C corporation, the LLC itself pays tax on its income.
- A one-person LLC is treated as a sole proprietorship — the IRS disregards the LLC structure at tax time.
The K-1 Form
The LLCs' K-1 form tells you how much profit or loss you made from the company this year. It lists your share of the various types of income or loss the LLC might have received, such as regular business income, rental income, dividends or royalties. It also lists your percentage share of income, losses and capital and the state of your capital account – the amount you've invested in the LLC, less any money you've withdrawn.
Division of Income
Normally you divide up LLC income to reflect your stake in the business. If, say, you contribute 40 percent of the capital, you're entitled to 40 percent of the profits. However, if the company's in the red, you can claim 40 percent of the loss as well.
It's also possible to make special allocations that don't reflect a direct percentage of your actual investment. For example, if you put up 60 percent of the cash, but your partners run the company, your allocation might be less than 60 percent to reflect their sweat equity. This can turn into a tax dodge, so the IRS scrutinizes special allocations a lot more carefully when it comes to LLC taxation.
Distributions and Taxes
The K-1 lists distributions – withdrawals from income or from your capital account – that you've taken during the tax year. These distributions are not what you're taxed on. You pay tax on your share of the LLC's income, whether you withdraw it or keep it in the company.
Using the K-1
The IRS' K-1 instructions help you transfer the information on the K-1 to your personal return. The LLC's regular business income, for instances, goes on your Schedule E tax form. Investment income goes directly onto Form 1040. Capital gains or losses go on Schedule D.
Note that if you elect to have the IRS treat your LLC as an S Corporation, you receive a K-1. However the K-1 form is different from the partnership paperwork.