Should you form an LLC? What it does — and doesn’t — do for your taxes

What an LLC is, and how it’s taxed by default

A limited liability company is created under state law. Its main job is legal: separating the business’s debts and liabilities from your personal assets.

Federal tax law doesn’t have an LLC category. The IRS taxes an LLC based on how many owners it has and any election it makes. That’s the source of most of the confusion.

Without an election, an LLC is taxed one of two ways:

• Single-member LLC: a disregarded entity. Income and expenses go on your personal return, usually Schedule C, just like a sole proprietorship.
• Multi-member LLC: taxed as a partnership. The LLC files Form 1065 and gives each owner a Schedule K-1.

Elections that do change the tax picture

An LLC can elect to be taxed as a C corporation on Form 8832, or as an S corporation on Form 2553. An LLC that timely files Form 2553 is treated as having also elected corporate status, so it generally doesn’t need Form 8832 as well.

Timing rules matter. A Form 8832 election can’t take effect more than 75 days before it’s filed or more than 12 months after. Once you change classification, you generally can’t change it again for 60 months. An S election for a full calendar year is generally due by March 15 of that year.

One quirk worth knowing: even a single-member LLC that’s disregarded for income tax is treated as a separate entity for employment taxes. If it has employees, it needs its own EIN and files payroll returns in its own name.

A worked example: same profit, same tax

A freelance designer earns $120,000 of net profit in 2026. As a sole proprietor, self-employment tax is about $16,955 ($120,000 × 92.35% × 15.3%). She forms a single-member LLC and changes nothing else. Her self-employment tax is still about $16,955, and her income tax doesn’t change either — the LLC is invisible on her Form 1040.

Her qualified business income deduction is also the same, because a sole proprietorship and a single-member LLC both qualify. What changes is the paperwork: a state filing fee, possibly an annual report or franchise tax, and a registered agent. The tax result only changes if she elects S corp status — which brings payroll, a reasonable salary, and its own costs.

If her profit grows, that election may eventually make sense, and having the LLC already in place makes the switch simpler. But the LLC by itself saved her nothing in tax; its value is the liability separation and the cleaner books that come with running a real entity.

Multi-member LLCs: partnership rules apply

Once an LLC has two or more owners, the default partnership treatment brings its own rules. The LLC files Form 1065 by the 15th day of the third month after year-end — March 15 for calendar-year partnerships — and issues each owner a Schedule K-1. Late returns carry a per-owner, per-month penalty, so the deadline matters.

Owners who work in the business generally pay self-employment tax on their share of trade or business income, including guaranteed payments for services. Guaranteed payments aren’t qualified business income, so how you structure owner pay affects the QBI deduction as well.

Profits and losses are allocated under the operating agreement, which is why a well-drafted agreement matters for taxes, not just governance. Each owner also needs to track their basis to know how much loss they can deduct and whether distributions are taxable.

Common myths

Under the default treatment, your net profit is still subject to self-employment tax, exactly as it would be without the LLC. A few other beliefs deserve a correction too:

• “An LLC lowers my taxes.” Not by default. Savings come from elections and planning, not from the entity itself.
• “I can deduct more with an LLC.” Ordinary and necessary business expenses are deductible whether or not you have an LLC.
• “My LLC is an S corp.” Only if you filed Form 2553 and the IRS accepted it. Check your acceptance letter if you’re unsure.
• “An LLC protects me from everything.” It doesn’t shield you from your own professional negligence or from debts you personally guarantee. If you mix personal and business funds or ignore formalities, a court may disregard the entity.
• “It works the same everywhere.” Formation fees, annual fees, and state taxes vary widely. Some states charge LLCs annual taxes or fees regardless of profit.
• “Forming an LLC in another state saves tax.” You generally still register and pay tax where you actually do business.

State costs to check

The federal treatment is the same everywhere; the state treatment isn’t. Before forming, look up your state’s formation fee, annual report fee, and any minimum franchise or gross-receipts tax that applies even in a loss year.

If you elect S corp status later, check whether your state recognizes the election and whether it imposes its own entity-level tax. Some states also let pass-through entities elect to pay state income tax at the entity level, which can matter for owners limited by the federal SALT deduction cap.

Local taxes can apply too. Some cities and counties impose business license taxes or gross-receipts taxes on LLCs, so check local rules before you register, especially if you work from a home office in a city with its own business tax.

When it’s worth it

An LLC often makes sense when you have real liability exposure, want a clean separation between business and personal finances, or expect to elect S corp status later. It can also make banking, contracts, and adding a partner simpler.

Licensed professionals should check state rules first. Some states require licensed professions such as law, medicine, and accounting to use a professional LLC or professional corporation, and some don’t allow LLCs for certain professions at all.

Insurance still matters. Professional and general liability coverage protect you in ways an LLC can’t.

If you form one, run it properly

That discipline supports both your liability protection and a clean tax return:

• Get an EIN and open a separate business bank account and card.
• Sign contracts and invoices in the company’s name.
• Keep books that tie to your bank statements every month.
• Pay yourself through documented owner draws, or through payroll if you elect S corp status.
• Keep your operating agreement current, especially if there’s more than one owner.
• File state annual reports on time so the LLC stays in good standing.

A note on federal beneficial ownership reporting

Many owners remember warnings about beneficial ownership information (BOI) reports under the Corporate Transparency Act. FinCEN now states that U.S. companies are exempt and no longer required to file BOI reports. Foreign companies registered to do business in the U.S. may still have obligations, and state-level reporting rules are separate, so confirm what applies to you.

If you’re weighing an entity or an election, the decision turns on your actual profit and state. At Tally Tax, that review starts with last year’s return and this year’s projections.

Frequently asked questions