By Gary Smith
You’ve been told you need a limited liability company (LLC) for your business. You filed Articles of Organization with the North Carolina Secretary of State, not just in your filing cabinet. (I had a client do that once.) Now, people are asking how it’s taxed. It’s taxed like an LLC, right?
Yes, it is, but that means it’s taxed for income tax purposes like one of four other types of entities. Your LLC isn’t just an LLC—at least not in the eyes of the income tax code.
Understanding the tax implications of your business structure is crucial. Today’s blog will address several tax considerations related to establishing an LLC.
Which LLC is Right For You? – Income Tax Options
One Owner – If your LLC has only one owner, the default setting is that it doesn’t exist for income tax purposes. If you own it individually, it’s treated like a sole proprietorship. The income and expenses are reported on your individual tax return. (Yes, it exists for liability protection purposes and state law purposes. This is just for income tax. P.S. It may be treated as separate from you for sales and use taxes, too.)
More than One Owner – If your LLC has more than one owner, the default setting is that it’s taxed like a partnership. It files a Form 1065, and its owners are treated as “partners” who get a K-1 Statement each year to add to their individual tax returns. But don’t call it a partnership. It’s not legally a partnership, and that’s important for liability protection purposes.
Corporation – Here’s the interesting part: you have the flexibility to choose how your LLC is taxed. Whether you’re a sole owner or have multiple owners, you can opt for your LLC to be taxed as a corporation. This option requires a specific filing with the IRS.
So, there are three ways to have income taxed. What’s the fourth?
C Corp vs. S Corp
When you decide to have your LLC taxed like a corporation, the default is that your corporation is taxed under Subchapter C of the income tax code. It’s a “C” corp. However, if you meet certain requirements (which most privately-owned operating businesses do), you could choose to have your LLC taxed under Subchapter S of the income tax code. It could be an “S” corp.
If you have an LLC with one owner, it can be “disregarded” (think sole proprietorship), a “C” corp, or an “S” corp for income tax purposes. If you have an LLC with more than one owner, it can be a partnership, a “C” corp, or an “S” corp for income tax purposes. But no matter how it’s taxed for income tax purposes, it’s always a limited liability company. It’s not a limited liability corporation, corporation, partnership, limited partnership, limited liability partnership, limited liability limited partnership, or sole proprietorship. Details matter here.
Oh, and these four types are just for federal (and sometimes state) income tax purposes. Some states have additional decisions for you to make about the type of limited liability company you have.
Considerations: Choosing the Right LLC
So, what should you choose for your LLC for income tax purposes?
It depends on:
- Who the owners will be (individuals or other entities; citizenship (the U.S. or another country); residency);
- How many owners will there be (“S” corps have 100 or fewer owners);
- How will you share the profits and losses (by percentage ownership or another method);
- If you want to be able to use losses generated by the LLC against other taxable income you have (partnerships and S corp’s have different rules);
- The type of business or assets your LLC will own (how likely is ownership to change; will the assets appreciate or decrease in value; will the business or assets change over time);
- What states and other countries you will potentially have to file tax returns in (sometimes an LLC isn’t the best option because of a law in a specific state or other country); and
- Any specific regulations that apply to what you will do in the LLC.
Additionally, there are checklists more than four pages long in a 10-point typeface used to determine the best choice for you, and these checklists contain questions only trained professionals can answer. (By the way, for everything you’re doing, you may need more than one LLC or some other variety of entities for liability protection, income tax, and estate tax purposes. And the answers for what entities to choose could differ depending on which of those three purposes is most important to you.)
At the end of the day, you shouldn’t expect to be able to answer these questions yourself (unless you’re a tax attorney or accounting/financial professional who is supposed to know the answers). You need to be able to tell someone what you want to do, to have them ask you a few questions to clear up any issues and to get advice (including an explanation of why) on what you should choose to do.
I’ve been involved in transactions where the business owner didn’t know how or why there was a corporation, LLC, or other entity, and it was taxed like a partnership, C corp, S corp, or something else. Some owners were surprised to find out what they had (or didn’t have because nothing was filed with the state). They were more surprised to learn what it meant for their checkbooks after taxes were paid. Note – The 15th day of certain months, like April, is not the time to be surprised by the taxes you owe.
The bottom line is that if you aren’t sure what you have or why you have it, you need to find out now. If you have changed owners, the business has grown or changed, the assets have grown or changed, or it’s been a few years since you last looked, you need to be sure you have what you need now. That changes.
Venn Law Group can help you understand the answers and advise you about your options. We can also help you make any needed changes. Contact us today to learn more.
Gary W. Smith is an attorney at Venn Law Group with more than 20 years’ experience providing legal counsel and innovative solutions to business owners and management teams. His areas of focus include mergers and acquisitions, succession and exit planning, securities and capital structures, business structures, and tax. He excels at navigating the legal complexities of diverse industries ranging from professional services and IT infrastructure to manufacturing and real estate.
Gary W. Smith is an attorney at Venn Law Group with more than 20 years’ experience providing legal counsel and innovative solutions to business owners and management teams. His areas of focus include mergers and acquisitions, succession and exit planning, securities and capital structures, business structures, and tax. He excels at navigating the legal complexities of diverse industries ranging from professional services and IT infrastructure to manufacturing and real estate.