When you choose to form an LLC (Limited Liability Company), not only are you releasing yourself from personal liability, you are also choosing the greatest flexibility when it comes to taxation. You can elect to be taxed as a partnership, a C or S corporation or a sole proprietorship as long as your LLC is “single-member”. The following are a general highlight of four different methods to consider when choosing how you want your LLC to be taxed.
Federal Taxation as a C-Corporation
- A C-Corporation is considered a separate entity for federal tax apart from its shareholders.
- The C-Corporation must file its own tax return and pay whatever tax is owed.
- The major disadvantage to filing as a C-corporation is the concept of “double taxation.” The government taxes corporate earnings as the corporation earns the income and taxes the earnings again when the corporation distributes the money to shareholders.
- The C-Corporation is becoming increasingly less relevant as an effective method of paying reduced taxes, because individual income tax rates have dropped substantially.
Federal Taxation as an S-Corporation
- Shareholders of S corporations report income and losses on their personal tax returns and are assessed tax at their individual income tax rates.
- This allows S corporations to avoid double taxation on the corporate income.
- Biggest advantage of filing as an S Corporation is any business income or loss is “passed through” to shareholders who report it on their personal income tax returns.
- Disadvantage of filing as an S Corporation may be more complex tax returns and tax issues. Corporate taxes are more difficult and complex to prepare, with more schedules and issues relating to ownership and dividends.
Federal Taxation as a Sole Proprietorship
- The member of the LLC reports all the economic activity of the LLC on their personal income tax return
- The taxpayer then pays any tax associated with the LLC on their personal income tax return.
- An advantage to having an LLC taxed as a sole proprietorship is how easy it is to report the income or loss of the LLC.
- A few disadvantages being that generally a person who files under schedule C, which you have to do in a sole proprietorship, often gets audited at a higher rate. Also, members of the proprietorship must pay their own self- employment taxes.
Federal Taxation as a Partnership
- The partnership is similar to the S-Corporation method of income taxation in that the entity is considered a pass-through entity.
- The owners of an entity taxed as a partnership must report all the economic activity of the entity on the owner’s personal income tax returns.
- One advantage of being taxed as a partnership is they are not subject to the double taxation problem that plaques entities taxed as C-Corporations.
- One disadvantage is that the reporting requirements can be much more complex than that of the other entities. The instructions on the partnership form from the IRS estimates that one should spend 35 hours on keeping and maintaining partnership records, 24 hours on learning about the law and form, 35 hours preparing the form, and 3 hours copying and assembling the form to send to the IRS. This amounts to 97 hours spent on completing your partnership informational tax return.
Each of these methods is completely your choice. Once you form an LLC, you have 75 days to decide on one of these four methods. It is highly recommended that owners or members of LLCs seek professional assistance about tax issues.
Tax attorneys exist who specialize in assisting owners of LLCs in maximizing the tax benefits associated with ownership of an LLC. The American Bar Association provides resources to assist in finding this type of legal representation. Our knowledge center at MaxFilings can help answer many of your questions regarding each of these types of businesses.