LLC Electing to be Taxed as a Corporation: Everything You Need to Know
An LLC electing to be taxed as a corporation is quite common, particularly for those LLCs electing to be taxed as an S corp.3 min read
2. Advantages of Being Taxed as a Corporation
3. Disadvantages of Being Taxed as a Corporation
An LLC electing to be taxed as a corporation is quite common, particularly for those LLCs electing to be taxed as an S corp. Since an LLC has great flexibility in terms of its management structure, it can choose to be taxed in various ways.
An LLC, or limited liability company, is authorized by state statute. Therefore, depending on the state in which you choose to register your LLC, there will be certain requirements that must be met when forming your business.
An LLC operates similarly to a corporation as it offers limited liability to its owners; this means that the owners of the business cannot be held personally liable for any money that the LLC owes to third parties. This means that their personal assets, i.e. car, home, bank accounts, etc., are protected.
If an LLC doesn’t elect to be taxed as a C corporation, then it will operate as a pass-through tax entity, meaning that all profits and losses of the business are passed through to the owners who report it on their individual income tax returns.
If the LLC elects to be taxed as a C corp, then it will need to pay corporate income taxes as well as personal income taxes for the shareholders who received dividends from the business. Therefore, the business will incur double taxation. But if the LLC elects to be taxed as an S corp, it will continue to pass the profits to the owners.
Electing Corporation Taxation
An LLC can elect to be taxed as a corporation, partnership, or sole proprietorship. Keep in mind that the Internal Revenue Service (IRS) doesn’t recognize the LLC as a taxable entity. By default, the LLC is taxed in one of two ways (depending on if you operate a single-member or multi-member LLC). If you operate a single-member LLC, then you will be automatically considered a disregarded entity and taxed as a sole proprietorship.
A multi-member LLC is automatically taxed as a partnership; the business will file an information return on Form 1065 and also draft Schedule K-1s for each member. This schedule reports how much money the member will identify on his or her personal income tax return. However, additional LLC tax options exist. Particularly, the LLC can choose to be taxed as a corporation. Remember that the LLC can be taxed as an S or C corp.
Advantages of Being Taxed as a Corporation
There are several advantages to being taxed as a corporation, including the following:
- Reduced taxes
- Not having to include all profits from the business on the personal tax return
- Reduced payroll taxes
Generally, the LLC will elect to be taxed as the type of structure that can provide for the lowest tax implications. Notably, the high-end of the personal tax rate for a sole proprietorship and partnership is even higher than a corporation. So if your taxable income, also referred to as your adjusted gross income, is high, then you should ensure that your business profits aren’t included in your personal income taxes. Therefore, having your business taxed as a corporation will provide you with a better outcome and lower tax implications.
Another benefit of having your business taxed as a corporation is the fact that not all of the business income needs to be reported on your personal tax return. In fact, S corporations can separate the owners from the business, which allows the owners to also be employees of the LLC. If the member also operates as an employee, then he or she will need to earn a reasonable compensation. The compensation paid to the member will be taxed at the personal tax rate, and will also have Social Security and Medicare taxes taken out. While such taxes are taken out, the compensation itself is not subject to self-employment taxes, which are much higher.
Disadvantages of Being Taxed as a Corporation
One of the biggest disadvantages of being taxed as a corporation is the potential for being double-taxed; this occurs only if you choose to elect status as a C corporation. Therefore, if you want to be taxed as an S corp, you will need to indicate as such.
Before you choose which type of tax election you will make, think about the benefits and drawbacks of electing tax status with each type. You could even speak to a tax professional who can assist.
If you need help learning more about electing to be taxed as a corporation, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5-percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with, or on behalf of companies like Google, Menlo Ventures, and Airbnb.