01/03/2026
Hey y’all!! Happy New Year!!
Now that the new year has passed, I’m back for Part 2 of my LLC tax tip. If you missed part 1 of this series, or any of our previous tips, feel free to visit our page at J. Chad McLamb, CPA.
As for Part 2 of my monthly tax tips series, I wanted to discuss tax tips on the different types of LLC’s and how they are taxed. This part will focus on Multi-Member LLC’s to understand how it will be taxed and how you may be able to reduce your tax liability in the future by making a couple changes. This will be a long chapter so, sorry in advance but there’s a lot to cover.
How Small Business LLC’s are Taxed - Part 2 will focus on Multi-Member LLC’s and their tax structures. (01/03/2026)
Many business owners choose to start their businesses as limited liability companies (LLCs) because the business structure offers certain legal and financial protections.
LLCs also offer business owners more flexibility in how they're taxed.
At formation, multi-owner LLCs are automatically taxed like partnerships. Partnerships are pass-through entities, just like disregarded entities and S corporations. Owners of an LLC are called “members”.
However, you have options. You may change your LLC's federal tax classification to either an S corporation or a C corporation. The best tax treatment option maximizes your tax savings when you file your small business taxes. Let’s take a deeper look…
Multi Owner (Member) LLC Taxation:
When taxed as a pass-through entity, multi-owner LLCs distribute earnings to each member based on an agreed-upon profit-sharing percentage.
Owners of LLCs taxed as partnerships take draws to pay themselves, just like disregarded entities.
The percentage of the LLC that you own, called your ownership interest, is normally the same percentage of profits that you report on your personal taxes. LLCs can change their profit-sharing percentages while maintaining ownership interest if they let the IRS know.
Though the standard multi-owner LLC pays tax through its owners, the LLC files Form 1065, an information return that details earnings.
For example, let's say an LLC with two members report $300,000 in taxable income on Form 1065. Let's calculate each member's taxable income:
Member 1
- 40% Ownership Interest
- $120,000 ($300,000 * 40%) Share of Income
Member 2
- 60% Ownership Interest
- $180,000 ($300,000 * 60%) Share of Income
Now, each member's taxable income is not necessarily the same as his or her draw. Draws don't usually affect members' tax liability because members are responsible for paying tax on their income share, not just the amount of their draw.
Multi-owner LLCs with an S corporation tax designation distribute earnings among members the same way as LLCs taxed as partnerships. The owner's wages are treated differently because S corporation owners are considered employees. The S corporation files an information return with Form 1120-S.
Multi-owner LLCs taxed as C corporations are subject to the 21% corporate tax rate for the 2025 year. Each member reports and pays tax on his or her salary earnings.
How LLCs as a Pass-Through Business are Taxed:
LLCs treated as pass-through businesses — disregarded entities, partnerships, and S corporations — pay tax through their owner or owners.
Let's say you're the only owner in an LLC that provides landscaping services. Last year, you had taxable income of $150,000, and you paid yourself $75,000.
As a disregarded entity, you report $150,000 of income to your self-employment tax software. Even though you only paid yourself $75,000, you're responsible for paying tax on the business's entire taxable income.
Multi-owner LLCs treated as a partnership pay tax similarly.
Four brothers agree to be equal members at LLC registration. The business has $600,000 in taxable income, and each got paid $150,000.
Taxed as a partnership, each brother reports one-quarter of business profits on his Form 1040. Each brother enters $150,000 ($600,000 divided by 4) of income on his Form 1040. Their $75,000 draws are irrelevant because they pay tax according to business earnings.
S corporations are taxed the same way in both examples, but the calculation of taxable income changes. Consult with your CPA because there may be tax advantages to being taxed as an S Corp.
How to Write Off LLC Business Expenses and Deductions:
In general, LLCs of any tax designation write off expenses and deductions just as other small businesses.
Where LLC tax classifications diverge is the owner's income from the business.
S corporation owners who actively participate in the business are employees, which means they must be put on the payroll and paid a salary or wage, which is subject to payroll taxes like Medicare, Social Security, and FUTA taxes.
What's special about S corporations? Any leftover earnings are considered distributions that are not subject to payroll taxes.
But, don't try to fool the system by making your business an S corporation and only paying yourself in distributions to avoid employment taxes: IRS Publication 535 requires that you pay yourself a "reasonable" salary. Consider consulting with your CPA here because there are tax savings if it’s setup correctly.
Owners of other pass-through businesses — disregarded entities and partnerships — aren't considered employees, and they're required to pay self-employment taxes on their share of the LLC's earnings, even if they didn't remove the money from their business's account.
Let's look at a few examples.
Consider an LLC with two equal members and $400,000 in income.
- Earnings before member’s pay
S Corp $400,000 - Partnership $400,000
- Member Salaries
S Corp $400,000 ($125,000 per member) - Partnership is N/A
- Member distributions
S Corp $150,000 ($400,000 - $250,000) - Partnership is N/A
- Amount subject to payroll tax and income taxes
S Corp $250,000 - Partnership $400,000
- Amount subject to income tax, not payroll tax
S Corp $150,000 - Partnership $0
Since partnership and disregarded entity owners cannot take salaries, their entire income is subject to payroll taxes. The money they take home, called a draw, generally does not affect their tax liability because they owe tax on all company earnings, whether the earnings are still in the business or their personal accounts.
Let's see what happens when there's no leftover profit:
- Earnings before member’s pay
S Corp $400,000 - Partnership $400,000
- Member Salaries
S Corp $250,000 ($125,000 per member)
Partnership is N/A
- Member distributions
S Corp $0 ($400,000 - $400,000) - Partnership is N/A
- Amount subject to payroll tax
S Corp $250,000 - Partnership $400,000
- Amount not subject to payroll tax
S Corp $150,000 - Partnership $0
The S corporation tax classification benefits businesses that earn significantly more than their owners' salaries. Businesses that are closer to the break-even point are better off sticking with the standard LLC tax designation.
When choosing the right tax designation for your LLC, look to your past earnings and calculate your tax liabilities under each classification. Review your business budget for next year and run the same calculation.
Your LLC's tax designation determines your small business bookkeeping practices. If you make a change, consult your CPA to get your books back on track.
I’ll be back next week to continue various tax tips as we focus on the 2026 business and individual year.
If you have any tax topics you’d like me to discuss, please let me know by commenting on this post, calling or emailing me or by visiting my website at
https://chadmclamb3.wixsite.com/chadmclambcpa
I hope you had a great New Year and I’m hoping for a prosperous 2026 for you and yours.
Thank you so much.
J. Chad McLamb, CPA
J. Chad McLamb, CPA provides trusted, affordable and personalized accounting services to a broad range of clients across the triangle area. As your Certified Public Accountant, I’m here to ensure that all of your financial decisions are made carefully and with your best interests in mind. Whatever...
