What is a Limited Liability Company?
When you are planning to start a small business, one of considerations is what business form can provide personal protection to the business owner while also providing flexibility to run the business itself. The LLC offers the best of both —the limited liability feature of a corporation and the flexibility of partnership. A Limited Liability Company (LLC) is an unincorporated business structure registered under state statute.
Tax Classification of a Limited Liability Company (LLC)
Although an LLC is a legal form of business, subject to the laws of the state of formation, the IRS does not recognize an LLC as a business category for federal income tax purposes. There are no federal income tax forms specifically designed for LLCs. An LLC is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes) when there is one owner and a general partnership when there are two or more owners, unless an election is made to treat the LLC as a corporation for tax purposes under the so-called IRS “check-in-the-box” regulations.
“Check-the-box” election
Under IRS regulations regarding entity selection, unincorporated entities such as limited liability companies are generally permitted to choose whether they will be treated corporations. This entity classification election (referred to as a “check-the-box” election) is made by filing IRS Form 8832, Entity Classification Election. The procedure to make a check-the-box election is quite easy. The taxpayer must check the appropriate box, specify the date the election is to be effective, sign and file the form. Generally, an election specifying an LLC’s classification cannot take effect more than 75 days prior to the date the election is filed, nor can it take effect later than 12 months after the date the election is filed. An LLC may be eligible for late election relief in certain circumstances.
Tax Consequences of Change in Tax Classification
An LLC with either a single member or more than one member can elect to be classified as a corporation rather than be classified as a partnership or disregarded entity under the default rules discussed earlier. File Form 8832, Entity Classification Election, to elect classification as a C corporation. File Form 2553, Election by a Small Business Corporation, to elect classification as an S corporation. LLCs electing classification as an S corporation are not required to file Form 8832 to elect classification as a corporation before filing Form 2553. By filing Form 2553, an LLC is deemed to have elected classification as a corporation in addition to the S corporation classification. Regardless of change in entity election for federal tax purpose, the LLC form remains in place for other purposes. Once change is made, the entity ordinarily may not change its classification during the 60 months after the effective date of the election. It is important for the taxpayer to understand the tax implications of changes in an entity’s classification.
If the LLC is classified as a corporation, it must follow the corporation rules and file a corporation income tax return. If it is a C corporation, it is taxed on its taxable income and distributions to the members are includible in the members’ gross income to the extent of the corporation’s earnings and profits (double taxation). If it is an S corporation, the corporation is generally not subject to any income tax and the income, deductions, gains, losses, and credits of the corporation “pass through” to the members.
