Keeping up-to-date on Colorado LLC taxes will help you take full advantage of opportunities as they arise and avoid lesser-known pitfalls and common misconceptions associated with Colorado LLCs. Tax laws that govern LLCs change on routine basis. Understanding these changes and how they affect your company can help you determine which classifications and practices to implement, and when you may need to seek expert tax and legal advice.
Forming an LLC in Colorado can also be an important part of a larger estate plan and tax minimization. Find out more about forming a Colorado LLC and registering a Colorado business by clicking the respective links.
How is an LLC Taxed in Colorado?
The IRS classifies LLCs as pass-through entities by default. The pass-through classification signifies that a company’s tax liabilities are passed on directly to the personal tax return of the owner or owners of that company. In other words, the owners record the company’s profits and losses directly as their own. The limited liability company does not file its own tax return.
As LLCs are pass-through entities, the owners of the LLC will pay the flat Colorado income tax rate of 4.63% on the profits. This is different from corporation as it avoids double taxation because the LLC and the owners are considered a single legal entity.
Some think believe forming an LLC in a state, e.g. which does not have income tax, will free them up from having to pay income tax, but this is not the case. Income tax applies based on where the owner lives, not where the LLC is formed. So, if the LLC owner lives in Colorado, for example, then it is Colorado’s income tax rate that applies, even if the company is organized elsewhere.
What Taxes Does an LLC Pay?
Disregarded entities and partnerships are the two main distinctions within the IRS default classification. If your LLC has a single owner, it receives disregarded entity classification. Whereas, if your LLC has multiple owners, it receives a partnership classification.
Due to their pass-through entity status LLCs bypass double taxation. Double taxation occurs with corporations because the IRS considers them separate legal entities from their shareholders. This means a corporation must file a corporate tax return separate and apart from what the owners file. However, LLCs avoid this, as the IRS treats them like sole-proprietorships or partnerships.
Is an LLC Better for Taxes?
An LLC will pay no more in taxes, and will often pay less, than a sole-proprietorship. An LLC also has a number of taxable classifications which allow you to choose the one that fits for your situation. America's tax laws reward business ownership, and forming a limited liability company is often the easiest way to benefits from the tax laws.
Beyond the default classifications, an LLC may also opt to be taxed as an S-Corp or a Corporation. In the reverse, a Corporation cannot opt to be taxed as a disregarded entity or a partnership. For this reason, Colorado LLC taxes are more flexible than corporation taxes. That is, every form of taxation available to a Corporation is available to a limited liability company, but the opposite is not true.
Which is best for you will depend on a variety of factors, and will often by influenced by income you generate outside of the single LLC you have in mind.
Using an LLC for wealth planning and investment can offer flexibility and opportunity to families, should they understand the rules that govern these entities. In addition, many find that the LLC structure provides their family with effective means for financial planning and goal-setting, and in this sense use their LLC as a wealth-planning tool.
When given as gifts, fair market value determines the LLC unit value. This value corresponds to the acceptable price that either party, buyer or seller, would agree upon given that both parties have knowledge of the relevant facts and an unpressured willingness to buy and sell, respectively. With this in mind, when the LLC’s underlying assets are less than fair market value, the gift donor may be able to transfer greater value in LLC units.
There are a few different ways of obtaining profits from your LLC. Your own method will depend on the tax election your LLC made with the IRS. One such way is by declaring distributions, which allow members to receive an amount proportional to the number of shares they own, otherwise known as a pro-rata dividend. Another way is through the LLC paying salaries to its members through use of management fees. Also, LLCs can offer loans to members that match market interest rates. Finally, members can use paid distributions to buy additional LLC units, which reduces the taxable estate of the owners and provides them with a cash source.
Registering a Business in Colorado
Registering a business in Colorado provides tax benefits not otherwise available to individuals. Discounts for minority shares and unearned income are just a few benefits otherwise unavailable to sole-proprietorships.
Gifting & Gift Taxes
When difficulties arise with gifting assets, such as dividing up fractional interests of businesses or real estate, LLCs offer a unique solution. With an LLC, it is possible to gift fractional interest, much like shares of a stock, that represent the LLC’s assets as a whole. Each associated member would own a percent of the underlying value.
There are limits in place for gifts with an LLC. $13,000 is the annual limit on gifting that can occur before paying gift tax for a single recipient. If it is a joint gift made by spouses, the amount is $26,000. So, if a couple had three children, for example, the total amount that the couple could gift their children in a year without gift tax would be $78,000.
LLCs can offer additional protection when it comes to gifted interests. Depending on the agreements reached by members, it is possible to put restrictions on transferring LLC units outside of the LLC. Additionally, restrictions help secure the overall structure and underlying assets of the LLC from outside creditors, divorce proceedings, and any other wasting or spending concerns that can occur with cash or property.
Income Tax & Franchise Tax Savings
In some cases, LLCs may provide an opportunity for savings in income tax. If certain members are of a lower tax bracket, income shifting to those members may achieve this. Additionally, there are instances where savings in franchise tax are achievable with LLCs, but it relies heavily on jurisdiction. Considering state law is important for both franchise and income tax as it pertains to your LLC.
Colorado LLC Filing Requirements
Enlisting the services of a CPA for LLC planning, formation, and compliance is a smart choice. A CPA will be up-to-date on tax and compliance matters and can also offer guidance in structuring a comprehensive estate plan. Tax and legal fees, as well as fees for estate planning often are tax deductible and have the option to be amortized, beginning with the LLCs inception date. Additionally, consider a CPA when filing the LLCs federal income return for assurance of proper preparation and compliance. This process involves complex accounting and can require expert tax and legal advice to determine how federal and state securities law applies, as well.