Limited liability companies (LLCs) are a popular choice of entity for small businesses and investment activities.
LLC owners are called members. Single-member LLCs have one owner, although spouses who jointly own an LLC in a community property state can receive treatment as a single-member LLC for federal income tax purposes. LLCs with two or more members are called multimember LLCs.
Key point: LLCs are not corporations. But, LLCs can offer similar legal protection to their members (owners).
Here are the most important things to know about LLCs:
LLCs Offer Legal Protection: Using an LLC to conduct a business or investment activity generally protects your personal assets from business-related liabilities—similar to the legal protection offered by a corporation.
NOTE: No type of entity (including an LLC) will protect your personal assets from exposure to liabilities related to your own professional malpractice or your own wrongful acts.
Single-Member LLC Tax Basics
Single-member LLC businesses owned by individuals are treated as sole proprietorships for federal income tax purposes unless you choose to treat the single-member LLC as a corporation.
In other words, the default federal income tax treatment for a single-member LLC business is sole proprietorship status. Under the default treatment, you simply report all the single-member LLC’s income and expenses on Schedule C of your Form 1040.
If the single-member LLC business activity generates net self-employment income, you will report that on Schedule SE of your Form 1040.
Taxes for Specific Types of Businesses:
Rental: If the single-member LLC activity is a rental activity, you report the rental income and expenses on Schedule E of your Form 1040.
Farm or ranch: You report the numbers for a farming or ranching activity on Schedule F.
Simple: You don’t need to file a separate federal income tax return for the single-member LLC. And other things being equal, simple is good.
Three key points
1. The big advantage of operating as a single-member LLC is extreme simplicity in federal income tax filing.
2. The big non-tax advantage is liability protection (under applicable state law).
3. As mentioned, you can elect to treat a single-member LLC as a corporation for federal income tax purposes, but we don’t recommend that, for reasons we explain later.
Multimember LLC Tax Basics
|Multimember LLCs are treated as partnerships for federal income tax purposes unless you elect to treat the LLC as a corporation.|
In other words, the default federal income tax treatment of a multimember LLC is partnership status. Under the default treatment, you must file an annual partnership federal income tax return on Form 1065.
From the Form 1065 partnership return, the LLC issues an annual Schedule K-1 to each member to report that member’s share of the LLC’s income and expenses. The member then takes those taxable and deductible amounts into account on the member’s own return (Form 1040 for a member who is an individual).
The LLC itself does not pay federal income tax. This arrangement is called pass-through taxation because the income and expenses from the LLC’s operations are passed through to the members, who then take them into account on their own returns. (The same pass-through taxation concept applies to entities set up as “regular” partnerships under applicable state law.)
Electing to treat the LLC as a Corporation for Tax Purposes:
You have the option of electing to treat a single-member LLC or multimember LLC as a corporation for federal income tax purposes. You do that by filing IRS Form 8832, Entity Classification Election, to change the default classification of the single-member LLC or multimember LLC to the new classification as a corporation.
If your desire is to have your LLC treated as an S corporation, it can elect S corporation status directly using IRS Form 2553, or it can elect C corporation treatment on Form 8832 and then S corporation treatment on IRS Form 2553.
While there may be valid non-tax reasons for electing to treat an LLC as a corporation, we think tax reasons generally dictate against taking that step.
The legislations and tax rules can change, Please make sure to talk to your CPA and/attorney before you take any decisions.