1. Operating Agreement
2. LLC Types
3. LLC Tax Classifications
4. LLC Corporate Combination
5. LLC Tax Benefits

The benefits of an LLC include liability protections, tax savings, and a flexible management structure. An LLC is a newer legal entity when compared to partnerships and corporations. The LLC is created in the state where you register the entity and through the filing of an articles of organization.

Regardless of which entity you choose, your choice has long-reaching implications in the following areas:

  • How entities pay taxes
  • Personal liability
  • Regulation types

With that, the most common entity that many business owner choose is an LLC. It is an easier registration process, and it has more adaptability for small businesses. LLCs also share similarities with C and S corps and enjoy greater flexibilities than other entities.

Operating Agreement

LLC members should draft an operating agreement that outlines the basic management structure of your business. Although most states do not mandate an operating agreement, you should have one in place to effectively manage your business.

LLC Types

Regarding single member LLCs/sole proprietors, you must use Schedule C with the tax return, and the net business income would be added to the owner’s income on his or her tax return. For multi-member/partner LLCs, a partnership return gets prepared using Form 1065, and the owner’s income is determined using Schedule K-1, and then reported on the individual return.

  • Note: On the other hand, a corporation pays business taxes, but the corporate owners can also save on employment taxes if they classify themselves as employees if they do additional work for the business.

Since an LLC is fairly recent, the IRS does not have a certain tax category for LLCs, which is why LLCs use other tax categories.

LLC Tax Classifications

LLCs do not have a federal tax designation, but owners can choose a tax status in the following categories:

If members or owners fail to act, the LLC will get taxed as a partnership by default. With that, owners can choose to have the entity taxed in the same way as a corporate entity. The IRS does not designate an LLC as a separate entity for tax reasons, meaning that the IRS also does not impose direct taxes on LLCs. For sole-member LLCs, an LLC would be taxed as a sole proprietorship, and multi-member LLCs are taxed as partnerships.

LLC Corporate Combination

If LLC owners want to retain business profits to foster expansion, they can choose the structure of a C corp. Under this route, LLC profits would only be subject to the 15-percent corporate tax rate, which is less than a member/owner personal income tax rates. If the owners want to get compensation, they can also receive W-2 income for duties within the company. With that, LLC owners who wish to get a portion or all of the profits should choose an S corp classification.

All owners/members can get a pro-rated share of LLC bottom-line profits in the form of distribution profits. (taxed at individual income tax rates, but it is not open to self-employment taxes).

The benefits of an S corp and LLC combination include:

  • LLC can have over 75 members
  • Nonresident aliens can be owners
  • Corporations and partnerships can be owners
  • Over 80 percent ownership in a different corporate entity
  • Flow-through loss deductions
  • Members/owners who play an active role in managing the business would not lose liability protection

LLC Tax Benefits

When it comes to tax rates, the rate itself depends on the income of the owners. For high-level net income, the LLC could pay taxes at a lower rate than corporations. For instance, for income of $75,000, the taxable business income would be 34 percent, and the personal tax rate would be 35 percent.

In regards to double taxation, C corp owners must pay business income taxes, but LLC owners do not. A C corp pays taxes on net business income, and owners would pay taxes on dividends received. LLCs avoid double taxation through pass-through taxation. Pass-through taxation allows business activity to flow from the business to individual members, where they file such information on their individual tax returns.

Also, S corp get around double taxation in the same manner. With that, all corporations are not eligible for S corp tax treatment.

  • Note: Certain corporations must also pay business franchise taxes, but other states may not require LLCs to pay such a tax. Franchise taxes vary by state.

To know more about the benefits of an LLC, submit your legal inquiry to our UpCounsel marketplace. UpCounsel’s lawyers will give you more insight into the benefits and limitations of an LLC, and how you need to register in your state. Also, they will help you maximize tax benefits that LLCs have to offer.