LLC Treated as Partnership: Everything You Need to Know
An LLC treated as partnership is an option for business owners looking to take advantage of the benefits of both types of business structures. 3 min read
An LLC treated as partnership is an option for business owners looking to take advantage of the benefits of both types of business structures. Many business owners, accountants, and attorneys debate whether an S corporation or an LLC is the right setup for a business. However, it's best not to look at this as an either/or proposition. Instead, a business owner can set up an LLC and have it be treated as an S corporation or a partnership for taxation purposes.
LLC Electing S Corp Status
When an LLC operates an active business or trade, Self-Employed Contributions Act (SECA) or payroll taxes on the owners can be high. As a result, electing for taxation as an S corporation might be the best choice. S corporations and LLCs are pass-through entities, meaning income passes through the business to the owner(s). Additionally, both entities offer limited liability protection to the owners. Although they share some similarities, these two types of business entities have some differences, as well.
New business owners should consider these differences when choosing a company formation:
- S corporations have advantages in tax planning.
- LLCs have advantages in ease of administration and operation.
- S corporations have advantages in flexibility for paying business owners as earned income or distributions.
- LLCs have advantages in flexibility to allocate a percentage of the losses or profits among business owners.
Before making a choice or deciding to form a business with a combination of the two entities, decide on which features are most critical to you and any other business owners.
LLCs Offer Limited Liability and Flexibility
An LLC is one of the most flexible options for setting up a business. This business structure is legally authorized by state-specific statutes. It combines the advantages of limited liability available through formation as a corporation with the operational flexibility and tax efficiencies of a business set up as a general partnership or sole proprietorship.
Unless the owners, called members, elect for taxation as a corporation, an LLC is a pass-through business entity. As a result, all losses and profits pass through the business to the members. Similar to a partnership or sole proprietorship, the members will report their share of the losses and profits on their own personal tax returns. Pass-through taxation is an advantage because it eliminates the double taxation that a corporation must pay on losses and profits.
Similar to a corporation, an LLC limits the members' personal liability. An LLC member's personal liability is generally limited to the amount that individual invested in the business. Limited liability is something that separates an LLC from a general partnership or sole proprietorship, as these business structures subject the owners to unlimited personal liability for any business debts or obligations. The features and benefits of forming an LLC make it a great choice for many business owners.
Some of the most significant and appealing features of an LLC include:
- Fewer restrictions around profit-sharing among members (they can distribute as they wish instead of being forced to distribute based on their percentage of capital contributions).
- Limited personal liability.
- All net earnings pass through to owners as self-employment income (subject to 15.3 percent Social Security and Medicare self-employment tax).
- Easier operation with fewer startup costs, forms to file, formal meetings required, and requirements around record-keeping.
- Income is passed through to members to prevent double taxation (unless members elect for taxation as a corporation).
An LLC is not officially recognized by the IRS as its own separate tax classification. The tax treatment under federal laws is distinct and separate from the limited liability offered under state-specific laws. Limited liability companies are treated as corporations, partnerships, or sole proprietorships for federal tax purposes, but they are still protected from personal liability.
By default, an LLC with a single owner is taxed as a sole proprietorship, while LLCs with multiple members are taxed as partnerships. However, by filing the Entity Classification Election (form 8832), an LLC elects for taxation as a corporation. After filing that form, the LLC can elect for taxation as an S corporation by filing the Election by a Small Business Corporation form (form 2553).
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