Limited liability companies offer a lot of flexibility when it comes to tax matters. Often, when I ask someone how their company is taxed, they’ll say “It’s taxed as an LLC” or maybe just “It’s an LLC.” That doesn’t tell me much, because LLCs can be taxed as sole proprietorships, partnerships, S corporations, and C corporations. That’s a lot of choices.
Under the IRS’s check-the-box rules, business owners can choose how their limited liability companies will be taxed when they apply for their federal tax ID (also known as an employer identification number or EIN).
Default tax classifications
The default tax classification for a single-member LLC is “disregarded entity.” This means that the IRS treats the company as if it were a sole proprietorship. The business owner reports the company’s profits and losses on Schedule C on his or her personal tax return, and the company itself doesn’t file a tax return at all. The actual company is disregarded from the IRS’s perspective.
If the LLC has more than one member, the default tax classification is partnership. The company files a partnership tax return on Form 1065 and issues a K-1 to each of the company’s members, who are treated as partners from a tax perspective. The members report their share of the company’s profits and losses from the K-1 on their personal income tax returns.
LLCs taxed as corporations
If a business owner wants their LLC to be taxed as an S corporation, they’ll need to file a Form 2553 with the IRS after they obtain their tax ID. This a a simple form and no fee is required. Assuming the IRS approves the election, the LLC will file an S corporation return on Form 1120S and issue each of its members a K-1. The members are considered to be shareholders from the IRS’s perspective, and they’ll report the profits and losses reported on the K-1 on their individual tax returns.
If the business owner wants their LLC to be taxed as a C corporation, they’ll need to file a Form 8832 after they obtain their tax ID. The company will file its taxes each year on Form 1120. Unlike LLCs taxed as S corporations, LLCs taxed as C corporations don’t issue K-1s to their members. The members receive W-2s for money they receive from the LLC in the form of wages, and Form 1099-Div for distributions.
As you can see, limited liability companies offer a lot of flexibility when it comes to how the company and its members are taxed. This is one of the most attractive features of LLCs when it comes to deciding what type of entity to form for your business.