If you’re thinking of forming a Limited Liability Company (LLC), one consideration is how forming the LLC will change your tax status as a business and as a business owner.
Here’s the deal:
Default Rule is that LLCs are Taxed as a Sole Proprietorship or a Partnership
If you don’t do anything to change it, the IRS assumes that a one-owner LLC is to be taxed as a sole proprietorship, and that a multiple-owner LLC will be taxed as a partnership. That’s what they mean when they say a LLC is a “pass-through” or “disregarded entity”—the IRS doesn’t care about the legal form of the business; they are just going to classify you based upon the number of owners.
That means the one-person LLC submits all the business records on their personal Form 1040 Schedule C, and you can even keep using Turbo Tax to do your taxes. The multiple-owner LLC has to file a separate partnership tax return (Form 1065) and then each owner gets a Schedule K-1 to report the income on their personal Form 1040. The Form 1065 & K-1’s are a bit more complicated than a Form 1040, and I recommend finding a tax preparer experienced with partnership taxes to help you.
Make a Special Election for Your LLC to be Treated as a S-Corporation
Here’s where you can get the benefit of having a S Corporation (reduction in self-employment taxes) while keeping the simplicity of having a LLC—by electing to have your LLC taxed as a S Corporation.
To make the election, you have to file two forms: Form 8832, to elect to be taxed as a “domestic eligible entity electing to be classified as an association taxable as a corporation” (wow, that’s a mouthful), and then Form 2553, to elect to be treated as a S Corporation. If you want to make this election and have it apply from day one, you need to make it within two months and fifteen days of when you formed the LLC.
One issue to remember: if you have your LLC taxed as a S Corporation, it has to comply with the IRS’ rules about S Corporations, including having only domestic shareholders (no non-resident aliens), no more than 100 shareholders, and have only one class of stock. For this reason, some LLCs will not qualify.
If you do decide to make the S Corporation election, the company will file a Form 1120S tax return, and you will receive a Schedule K-1 to reflect your profits as the owner. Similar to partnerships, this isn’t a tax return that I recommend you do on your own.
Talk to your accountant or business financial advisor about which tax status is more appropriate for you.
If you’d like to chat with me (Elizabeth) about the legal side of forming a LLC, set up a Quick Call!