Tax Treatment of Business Entities Part 2: LLCs
Startup business owners must consider the legal and tax considerations associated with selecting a particular type of business structure. This is the second part of a series of blogs on the tax treatment of business entities. This blog will address the tax treatment of limited liability companies (LLCs). LLCs are used by many business owners because, like corporations, their owners typically have limited personal liability for the debts and activities of the LLC. In contrast, some features of LLCs are similar to a partnership, such as pass-through or flow-through taxation.
A limited liability company is a business structure allowed by state statute. Thus, since there is always some variance in state laws, business owners must review and analyze the laws of each state to determine the specific requirements for forming an LLC in that particular state.
Owners of LLCs are referred to as “members,” which may include nonpersons such as corporations and other LLCs. Some states, including New York, New Jersey, and Connecticut, permit “single-member” LLCs. Not every type of business may be an LLC. This list usually includes banks and financial institutions.
An LLC and its members usually make an election to have the IRS treat the LLC as either a corporation, partnership, or as part of the LLC’s owner’s tax return when the owner is considered a “disregarded entity.” An LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation.
A “disregarded entity” is an LLC with only one member that is treated as an entity disregarded as separate from its owner for income tax purposes unless it files IRS Form 8832 and affirmatively elects to be treated as a corporation. However, a disregarded entity is treated as a separate entity for purposes of employment tax and certain excise taxes.
Unless they elect otherwise, multiple member LLCs are typically taxed as partnerships. Under partnership tax treatment, the business entity is a pass-through entity for tax purposes, which means it ordinarily pays no taxes itself. Instead, the profits, losses, deductions, and tax credits of the business are passed through the business to the owner’s individual tax returns.
If the business makes a profit, the owners pay income tax on their ownership share on their individual returns at their individual income tax rates. If the business incurs a loss, it is similarly shared among the owners who may deduct it from other income on their individual returns. As such deductions are subject to certain limitations, it is wise to consult with an experienced and knowledgeable tax professional to help any business assess their current tax situation as it stands in the present looking ahead to the future.
A tax professional may evaluate anyone’s situation to help determine the wisdom of any year-end tax savings moves. If you are an individual or business in the New York or Tri-State area and have any question about taxes, especially in planning ahead for the next filing season, call THE TAX EXPERTS at the Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation call 212-490-0704.