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This post originally appeared on the American Express OPEN Forum, where Mashable regularly contributes articles about leveraging social media and technology in small business.

The Limited Liability Company (LLC) is a hot business structure for startups right now — and for good reason. It offers all the personal liability protection without the red tape, paperwork and formalities that can be burdensome for a young startup, digital agency, small business or solo entrepreneur.

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But after settling on the LLC for the legal structure, many small business owners are surprised to learn there’s still one more decision to make: how to be taxed. Certainly this is a big decision, as taxes are probably what drove you to select a legal structure in the first place.

Because the LLC is an entity created by state statute (and not the federal government), it offers flexibility when it comes to federal tax treatment. A single-member LLC can choose to be taxed as a sole proprietorship or a corporation (either C Corporation or S Corporation). Likewise, a multi-member LLC can choose to be taxed as a partnership or a corporation (either C Corporation or S Corporation).

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Flexibility is always a good thing — you just need to know which option is right for you. Read on to learn more about the four different federal tax classifications available for the LLC.

1. Single-Member LLC as a ‘Disregarded Entity’

A single-member LLC is essentially taxed as a sole proprietor. As the name implies, you need to be the sole owner of the LLC. This classification falls into the “pass-through” taxation category” — the business itself doesn’t file any tax forms. As the owner of the LLC, you report business income or loss on your personal tax forms (Schedule C).

In addition, you will need to pay self-employment taxes if you’re engaged in active trade or business, for example, if you provide a service like copywriting or sell a product. If you formed an LLC for a passive activity such as a real estate investment, then you don’t need to pay self-employment tax on the profits (rather, you’d report your passive profits on Schedule E).

For example, let’s say Jonathan is a freelance UI designer who formed an LLC for his business. Through this work, he earned $75,000 in profit in 2011. He will report this income on his personal tax form and pay income taxes on the $75,000 at his individual tax rate, as well as pay self-employment taxes.

2. Multiple-Member LLC as a Partnership

For federal tax purposes, if an LLC has two or more members, it will be taxed as a partnership unless it makes an election to be taxed as an S Corp or C Corp (see below). In the case of a multi-member LLC taxed as a partnership, the LLC reports its business income on a separate 1065 partnership tax return. Then, each partner pays self-employment taxes on his share of the partnership profit on the Schedule SE tax form. As with the single-member LLC, self-employment taxes only need to paid if the LLC engages in an active trade or business.

3. LLC as a C Corporation

An LLC can elect to be treated as a corporation for tax purposes by filing Form 8832 with the IRS. In this case, the LLC files a corporate tax return 1120 and pays taxes on its profits at its corporate tax rate. If LLC profits are distributed to LLC owners in the form of dividends, those dividends are taxed again at the qualifying dividend rate (this is what’s known as double taxation).

The LLC profits are not subject to self-employment taxes, but an LLC treated as a C Corporation is responsible for payroll taxes on any wages paid to LLC members who work for the business.

If you prefer to keep profits in the company (as opposed to distributing any end-of-the-year profits to owners), a C Corporation would work. In this case, only the company is taxed on the profits; individual owners are not responsible for paying taxes on whatever money stays in the business.

For example, Judy owns a consulting company that earned $100,000 in profit. As an LLC treated as a C Corporation, the business would pay $34,000 in taxes on this income (assuming a 34% tax rate). If Judy then takes home that profit as a dividend, she would also owe taxes (at the 15% qualifying dividend rate) on the dividend payment. But if she decides to keep that money in the business (perhaps to expand her marketing budget next year), then she personally does not owe any taxes on the profit.

4. LLC as an S Corporation

In this last scenario, the LLC elects to be treated as an S Corporation. The S Corp files an 1120S tax return, but the company’s profits are not subject to corporate income tax like they are in the C Corporation. Instead, individual LLC owners are taxed on their respective shares of the company’s profits (and profits are not subject to self-employment tax). If an LLC owner works in the business, he must be paid a reasonable wage for his activities, and the LLC must pay payroll taxes on these wages.

Let’s say three friends start a social intranet company, and each owns one-third of the business. They form an LLC and elect to be taxed as an S Corporation. In the first year, the business earns $90,000 in profit. The LLC does not pay income tax on the profit. Instead, each owner includes his or her share of the profit ($30,000) in their taxable income on their individual tax return. And if the business lost $60,000 in the first year, each owner would include a $20,000 loss in his or her individual taxable income.

Do Your Homework

Choosing the right tax entity for your LLC is a complicated issue and will ultimately depend on all the unique aspects of your particular business needs, vision and circumstances. Investigate your options and stay on top of changing tax developments on both the federal and state levels that could affect your taxes. And since the decision can have significant financial implications, you won’t go wrong by discussing your particular situation with a tax adviser or CPA.

More Small Business Resources From OPEN Forum:

– Should Small Businesses Follow Everyone Back on Twitter?
– Are You Falling into the Pricing Trap?
– How to Innovate for Top Social Media Sites

Image courtesy of Image courtesy of iStockphoto, catenarymedia , Flickr, thinkpanama

This story originally published on Mashable here.