Written by Allison Kierman and Jeff Chirico
Limited liability companies (LLCs) are one of the most popular types of business entities. The LLC’s flexible taxation options are one reason it is preferred; LLC members can, for the most part, choose how they would like to be taxed. The LLC enjoys this flexibility because the Internal Revenue Service (IRS) does not recognize it as a distinct entity for federal tax purposes. It must, therefore, be taxed as one of the four taxable options already available:
- Disregarded Entity. A disregarded entity is a business structure that is not recognized as distinct from its owner for tax purposes. If you are the sole owner of a single-member LLC, the IRS classifies your company as a disregarded entity by default and taxes the LLC as a sole proprietorship. As a result, the owner of a single-member LLC must report the LLC’s income and expenses on the member’s Form 1040 Schedule C. A separate tax return for the entity is not required.
- Partnership. When an LLC has multiple members, the IRS’s default classification for tax purposes is the partnership. Partnerships, like disregarded entities, pass their income and expenses down to their owners, and LLC members are responsible for paying taxes proportionate to their ownership interests. Income, credits, and deductions are reported to the IRS using Schedule K-1 (Form 1065).
- Corporation. If an LLC does not want to be taxed as either a sole proprietorship or a partnership, it can elect to be taxed as a corporation by timely filing Form 8832. Electing taxation as a corporation may be beneficial in several ways. If the company does not intend to pay out dividends, electing to file taxes as a corporation allows LLC members to avoid reporting the business’s income on their personal income tax returns. Because personal income tax rates are often higher than corporate income tax rates, this may allow individuals to benefit from the lower corporate income tax rate. Additionally, LLC members may avoid paying self-employment taxes. Thus, corporate taxation may have money-saving benefits for LLC members.
Choosing the right structure for your business can be challenging. Business owners must carefully consider their choices and the complex taxation options at play.
Allison L. Kierman is the Managing Partner of Kierman Law, PLC, an Arizona estate planning and probate law firm based in Scottsdale, Arizona. Allison is also the Vice President of the Board of Directors for Congregation Beth Israel and Vice President, Legal Affairs for the National Council of Jewish Women of Arizona.
Jeff Chirico is the Co-Managing Partner of CK CPA Services, LLC, an Arizona tax and accounting firm.