This is the third and last installment in a series of articles which addresses the tax implications of various business structures. The business structure that an entrepreneur chooses for his or her business has both legal and tax implications. This installment will discuss the tax implications of a Limited Liability Company.
This series of articles has already discussed C Corporations and S Corporations. Both of these forms of business structure had the advantage of limited liability. But they both have disadvantages. The C Corporation has the disadvantage of double taxation, while the S Corporation has a lack of flexibility (for example, limits on the type and number of shareholders, etc.).
The Limited Liability Company(LLC) arose as an alternative form of business structure. LLCs are a relatively new business structure, arising from state law less than forty years ago. States viewed the LLC form of business as a way to attract companies to their State with a more flexible business structure. In 1988, after the IRS ruled that LLCs would be treated as partnerships for tax purposes, the number of States that created statutes allowing the LLC form of business grew exponentially (http://law.jrank.org/pages/8277/Limited-Liability-Company-History.html [accessed 12/2/2016]).
As a general rule, LLCs allow limited liability[1], pass through taxation to the individual owners, along with flexibility.
For example, as discussed in the Part 2-S Corporations, in the S Corporation structure, the owners must allocate profits and losses on a pro rata basis, dependent upon stock ownership on each day of the tax year. In LLCs, the partnership agreement governs the split of profits and losses, and special allocations are permitted. This means that the profits and losses may be allocated differently than on a pro rata basis which allows greater flexibility.
If the LLC has a single owner, the LLC will be taxed like a sole-proprietorship.[2] The single owner can include the revenue and expenses on their individual income tax return (Schedule C, Schedule E or Schedule F) (https://www.irs.gov/pub/irs-pdf/p3402.pdf [accessed 12/2/2016]). If the LLC has multiple owners, the LLC is treated as a partnership and files a Form 1065-U.S. Return of Partnership Income (https://www.irs.gov/pub/irs-pdf/p3402.pdf [accessed 12/2/2016]).[3]
The LLC seems like the best of all worlds, right? There are some disadvantages to an LLC. Since the LLC is considered either an entity disregarded as separate from its owner (one-member LLC) or a partnership (multi-member LLC), the net income to the owners is considered self-employment income and subject to self-employment tax.
Plus, remember that a multi-owner LLC is treated as a partnership for tax purposes. Several years ago, I heard a presenter at a tax conference state that partnership tax law is the most complex tax law in the U.S. Internal Revenue Code. (My response to that is that this presenter obviously had never been exposed to the U.S. tax law related to foreign transactions!).
Even so, partnership tax law, especially concerning partnership acquisitions and dissolutions, is very complex. This is something to keep in mind when choosing the LLC form of business. LLC’s may give you a lot of flexibility, but be sure you receive good tax and legal advice.
If you have any U.S. small business tax questions or need some help with your taxes, feel free to contact CPA WorldTax at taxinfo@cpaworldtaxllc.com or 888-512-4860.
[1] If you have questions on legal implications, please discuss with your attorney.
[2] If the LLC is owned by a husband and wife, the reporting options vary. Be sure to consult a qualified tax advisor.
(https://www.irs.gov/businesses/small-businesses-self-employed/single-member-limited-liability-companies [accessed 12/2/2016]).
[3] Unless the owners elect the check-the-box regulations to be taxed as a corporation. Treas. Reg. Sec 301-7701-2 (https://www.law.cornell.edu/cfr/text/26/301.7701-2 [accessed 12/2/2016]).