Why do so many businesses choose a Limited Liability Corporation (LLC) as their entity structure? An LLC can provide the advantages of a corporation while being taxed as a flow through entity, all while providing personal liability protection for its owners.
Shareholders (called “members”) in an LLC are only liable for the company’s debts to the extent of their own investment. This protects their personal assets from any creditors. Contrast that with the personal liability involved in a sole proprietorship or partnership, where the individuals who are actively involved in managing the business can be personally liable for any business obligations.
LLC Structure and Organization
An LLC is a business entity organized under state law. For tax purposes, an LLC is treated in one of three ways: as a corporation, as a partnership, or if the LLC only has one owner, as a disregarded entity.
Single Member LLCs and LLCs Taxed as Partnerships
An LLC with multiple owners is automatically taxed as a partnership, while an LLC with just one owner is taxed as a sole proprietorship while still being considered as an entity separate from the owner (a disregarded entity). Owners of single member LLCs and LLCs taxed as partnerships are not considered employees of the LLC. Instead, they are subject to self-employment taxes on the net earnings of the LLC.
Single member LLCs and those taxed as partnerships are pass through entities, meaning all gains and losses of the LLC flow through to the owners’ individual tax returns.
LLCs Taxed as a Corporation
Alternatively, an LLC can elect to be taxed as an S corporation or a C corporation by filing an election with the IRS. An LLC classified as a corporation (either C or S) must file a corporation income tax return (Form 1120 or 1120-S).
A C corporation is taxed on its taxable income, and distributions to the members are includible on their individual tax returns to the extent of the corporation’s earnings and profits. This means that the corporation’s income is taxed twice, once at the corporate level and once at the individual level.
An S corporation is generally not subject to any income tax on its own and all income, deductions, gains, losses, and credits of the S corporation pass through to the member’s individual tax return.
For More Information
Different states may regulate LLCs differently, so it’s important to be aware of your state’s rules. Give us a call if you’re interested in learning more about LLCs.