Taxation of LLCs

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The Federal income tax deadline is coming up tomorrow.  With that in mind, I thought it would be great to talk about how LLCs are taxed.  An LLC can be taxed as either a disregarded entity, a partnership, a C-corporation or an S-corporation.

A single-member LLC is treated as a sole-proprietorship and so the entity is disregarded for tax purposes.  If you are the sole owner of an LLC, you do not have to file a separate tax return unless you elect to be treated as a corporation.

By default, an LLC with two or more members is taxed as a partnership.  That means the LLC itself does not pay any taxes.  Each owner of the LLC must report his or her share of the profits and losses of the LLC on their personal tax returns.  Then the owners are taxed at their own personal income tax rate on their personal income tax returns.  This is why the tax on most LLCs is described as “pass-through.”  The income passes through the LLC and is paid by the owners.  There is no double taxation.

If the members of an LLC wish, they can elect to be taxed as a C corporation by filing an Entity Classification Election (Form 8832) with the IRS.  With C corporations, all profits of the corporation are taxed at the corporate level and then again after distributions are made to shareholders.  The current tax rate for United States C corporations is 21% on income.  Shareholders then pay an additional 23.8% on dividends they receive from the corporation.  This structure might make the most sense if a substantial amount of the corporate profits will remain in with the corporation and the shareholders are not taking significant distributions.

The members of an LLC can also elect to be taxed as an S-Corporation by filing a Form 2553, Election by a Small Business Corporation.  An S corporation combines the liability protection of a corporation with the pass-through taxation of a partnership.  They are very similar to LLCs, but have additional requirements to maintain their status.

If you are considering forming an LLC, don’t hesitate to call and discuss which option makes the most sense for you and your specific situation.

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