How are limited liability companies treated for tax purposes?

Limited liability companies (LLCs) are typically treated as pass-through entities for tax purposes, which means they do not pay federal income tax at the entity level. Instead, the profits and losses generated by the LLC are passed through to the individual members, who report this income on their personal tax returns. This treatment allows for the avoidance of double taxation, which can occur with corporations.

While an LLC can choose to be taxed as a corporation if it meets certain criteria, the default status is that of a pass-through entity, functioning similarly to partnerships in this respect. This structure provides flexibility in how income is taxed and can be advantageous for members regarding self-employment taxes and overall tax planning.

This is why the characterization of LLCs as nontaxable entities aligns with their treatment under most circumstances in terms of federal taxation. They're not completely devoid of tax obligations—LLCs may still face other taxes such as payroll taxes, sales taxes, or state-specific taxes. However, the essence of their treatment for income tax at the federal level marked them as nontaxable entities initially.