Based on the IRS website, partnerships and LLCs being taxed as partnerships appear to only file (at the federal level) 1065 forms with schedule K-1 forms (for each partner/member).

If I'm reading things correctly, that means businesses taxed as partnerships are only responsible for the self-employment taxes for each of their partners/members (i.e. their respective FICA contributions). This, in turn, should mean that a partnership's total, federal tax on earnings is 15.3% (as of 2018) so long as each partner makes below $118,500. This seems a little low compared to the alternatives. Are there really no other taxes or fees I'm forgetting about.

To be clear, this question is only about federal taxation.

  • Also worth noting that if the firm has employees who are not partners/members who owe self-employment taxes in lieu of FICA taxes, that the firm (rather than the partners/members) owe the FICA taxes and withholding taxes on the amounts paid to the employees. – ohwilleke Aug 12 '18 at 2:42

This really isn't about law, but I'll answer anyway as I've had an LLC for years...

LLC's (other than those taxed as C-Corps) are taxed as pass-through entities. That means that the income is "passed through" to the members based on the ownership share. Each member is then responsible for paying the appropriate taxes. The business itself is not taxed, nor is it responsible for paying the taxes of its members.

So yes, they (the members) pay normal income tax, self-employment tax, and any local taxes.

Lets take an example, Example LLC has 2 members Jack and John. Jack is a 75% ownership and John is 25% ownership. During the year the LLC takes in $250,000 in profits. The LLC files schedule K-1 with the IRS attributing $187,500 to Jack and $62,500 to John.

Jack pays taxes on $187,500 of income

  • AGI is $177,028
  • Standard deduction is $12,000
  • Taxable Income is $165,028
  • Tax before SET is $34,499
  • Self Employment Tax is $20,943
  • Total Tax bill: $55,442 (32% Tax Bracket)

John pays taxes on $62,500 of income

  • AGI is $58,085
  • Standard deduction is $12,000
  • Taxable Income is $46,085
  • Tax before SET is $6,078
  • Self Employment Tax is $8,831
  • Total Tax Bill: $14,909 (22%)

This scenario doesn't include local/state taxes that may also be levied, as well as any interest/charges if quarterly payments were not made.

So yes, an LLC with more than one member only needs to file form K-1 identifying with the IRS what portion of the businesses income is attributed to each member. This is not an obligation to pay any taxes on the part of the business, it is simply telling the IRS to "expect this much from X member". The IRS then uses K-1 to cross-check the members income tax forms that they file to be sure that they are paying appropriate taxes. If they don't match the member will get a bill (funny though I've never encountered the IRS voluntarily sending refunds if it differs in the members favor).

  • Also, to be up to the minute, it is worth noting that as of tax years beginning January 1, 2018, there is a 20% deduction for federal income tax purposes for income earned in a pass through entity (of course, the devil is in the details). My understanding is that this deduction does not impact self-employment taxes, however, and only impacts state income taxation if that is based on federal taxable income. – ohwilleke Aug 11 '18 at 21:40
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    @ohwilleke There are a whole bunch of "rules" that aren't set in stone yet about that "20%" deduction, which is why I didn't include it, but good point. – Ron Beyer Aug 11 '18 at 21:42
  • Also, while it rarely comes up, part of the penalty for failing to issue a K-1 is that an LLC or partnership that fails to do so, has penalty liability for all taxes not paid as a result of this income not being reported, so there is an obscure back door for entity liability. Also while beyond the scope of the OP, a few states do tax LLCs at the entity level even though the feds do not. – ohwilleke Aug 11 '18 at 21:43

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