District of Columbia 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 the District of Columbia, 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 District of Columbia and related aspects.

Classification of District of Columbia 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. The District of Columbia 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 the District of Columbia. These taxes are handled through the District of Columbia Workforce Commission.
  4. Franchise Tax Report – In the District of Columbia, 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 District of Columbia Office of Tax Revenue.

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 D.C.

An LLC in the state of Washington  has to pay two types of taxes to the Washington   Office of Tax & Revenue:

State Income Tax

An LLC member in Washington pays himself through the earnings he makes in the LLC. These earnings get reflected in your personal Tax return & are calculated at the time of paying the Income Tax. The Standard Washington State Income Tax rate ranging from 4% to 8.95% is applicable to your earnings. You get the opportunity to claim all the standard allowances & deductions upon filing the tax return.

State Sales & Use Tax 

The state of Washington levies Sales & use tax on tangible goods & services provided by an LLC. The State Sales & Use tax rate in Washington is 6.5%. However, certain localities or towns may charge an additional sales & use tax.

Federal Self-Employment Tax

Every member or manager of the Washington   LLC earning profit from the LLC has to pay the Federal Self-Employment Tax (also called the Social Security or Medicare Tax). 

The Federal Self-Employment Tax applies to all the earnings of an LLC member or manager. The Federal Self-Employment Tax rate in Washington is 15.3%. To deduct your LLC’s expenses from the income earned, you must calculate the Self-Employment Tax your LLC owes.

Federal  Income Tax 

Like State Income Tax, this tax also applies to the earnings you make in your LLC. The Federal Income Tax Rate is subject to the earnings you make, the type of your LLC’s industry, the LLC tax bracket applicable, deductions applicable, etc. 

Employee & Employer Taxes 

Any LLC with employees on the payroll has to pay different kinds of taxes that apply to all the employees. The Employee & employer tax implications are different from all the other types mentioned above. For Example, All employees of an LLC have to collect and withhold the Payroll tax at the time of receiving the salary. Irrespective of whether you withhold the Federal Tax or not, each employee has to file an individual 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. District of Columbia 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 the District of Columbia. 

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 District of Columbia 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 District of Columbia 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.

How Do LLCs Pay Taxes in District of Columbia

Any LLC operating in District of Columbia is liable to pay 2 kinds of taxes- state taxes as well as federal taxes.

How Do LLCs pay taxes in DC? Most DC businesses pay a single franchise tax, which is 8.25 percent of taxable income. While there’s no minimum franchise tax, you need to pay it if you earn more than $12,000 from DC sources. You can calculate your franchise tax by consulting a tax professional or contacting the District of Columbia’s Office of Tax and Revenue. The amount you owe depends on several factors, including how many employees you have, where your business is located, and whether you have a professional or an employee-based business.

First, you must file an Articles of Organization (AoO), which establishes your business. Make sure that you include an indicator that you are an LLC, and choose a registered agent in the District of Columbia. Make sure you have a DC street address. Finally, you should register your business with the DC Department of Consumer and Regulatory Affairs. There’s a $150 fee to file this report.

Next, you should file a Franchise Tax Report with the District of Columbia Office of Tax Revenue. This is necessary to file your tax return. If you don’t file an LLC’s Franchise Tax Report, the District of Columbia will tax your business as a corporation. This means you must pay federal employer tax as well as state taxes. The DC franchise tax is similar to that of a partnership.

In order to avoid an audit, file an annual Form D-20 with the Office of Tax and Revenue of the District of Columbia. For business receipts of more than $1 million in D.C., the minimum amount of payable tax is $250. Filing the Form D-20 should be completed between four and fifteen days after the end of the tax year. Make sure to include the business’ FEIN and tax year as well as a copy of DC Form QHTC-CERT.

In addition to a license, LLCs in the District of Columbia must register for sales tax. An LLC needs to register with the Office of Tax and Revenue (OTR). It is also required to submit periodic sales tax returns to the OTR. Luckily, these returns can be completed online and without any fee. You can get an EIN by mail or online, depending on your needs. It’s essential to know your legal obligations and deadlines when it comes to taxes and business registration.

Once your LLC has registered, you can begin filing your quarterly, annual, and yearly reports to the Office of Tax & Revenue. You should also file for an EIN with the IRS. A unique EIN helps identify your company to the government. This is necessary for filing taxes, opening business bank accounts, and even hiring employees. Obtaining your EIN is essential to keep your business registered.

Another important benefit of an LLC is that it can protect you from identity thieves. With simple information, an identity thief can steal your identity and run massive debts in your name. This is why establishing an LLC is so important. Despite this, there are still many advantages to creating an LLC. You can save money while you’re doing it. When it comes to taxes, LLCs are the best option.

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.

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.

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