User:Dgansman/LLC

Income Tax Default:

For U.S. federal income tax purposes, an LLC is treated by default as a pass-through entity. Pass through (flow) entities are not subject to federal income taxes. Rather, individual owners are taxed on the portion of gains/ losses assigned to them based on their respective portion of ownership. This function helps LLC business structures to avoid being taxed once at the business level and again at the owner's expense when income is distributed to shareholders .

Single Member: If there is only one member in the company, the LLC is treated as a "disregarded entity" for tax purposes (unless another tax status is elected), and an individual owner would report the LLC's income or loss on Schedule C of his or her individual tax return. Thus, income from the LLC is taxed at the individual tax rates.

Multiple Members: The default tax status for LLCs with multiple members is as a partnership, which is required to report income and loss on IRS Form 1065. Under partnership tax treatment, each member of the LLC, as is the case for all partners of a partnership, annually receives a Form K-1 reporting the member's distributive share of the LLC's income or loss that is then reported on the member's individual income tax return. On the other hand, income from corporations is taxed twice: once at the corporate entity level and again when distributed to shareholders. Thus, more tax savings often result if a business formed as an LLC rather than a corporation.

Flexibility in Taxation Election

Due to the wide variety in business functions, management objectives, and industry specific risk, LLC's are allowed a significant amount of flexibility in how their income/ losses are to be taxed. Members can elect taxation as either a Sole proprietorship, Partnership, or a Corporation. Deciding which of these to elect is one of the most critical choices an individual or group of entrepreneurs can make because of the choice's long reaching consequences, and in some cases, irreversible effects. S-Corp and C-Corp filing pros/ cons are briefly outlined below:

Characteristics of possible tax structures for LLC's to elect

Cooperate Tax

An LLC with either single or multiple members may elect to be taxed as a corporation through the filing of IRS Form 8832. After electing corporate tax status, an LLC may further elect to be treated as a regular C corporation or an S corporation.

a) C Corporation

C Corporations are structured to legally separate shareholder's assets and income from ownership in the company. Dividends/ distributions are taxed separately after net gains/ losses incur entity-level tax treatment, leading to a "double taxation" effect on owners.

Pros:

• Transferability of ownership - Ownership/ stock can be easily transferred from person to person without authorization of other shareholders.
• No restrictions on shareholders - Shareholders are not limited in number or citizenship status
• Easy to re-invest profits - Profits can be re-invested into the company with a tax-exempt status through Retained Earnings
• Entity can exist without original owner(s)

Cons:

• Susceptible to double taxation when receiving distributions/ disbursements

b) S Corporation

Unlike LLC's and C-Corporations, S Corporations are not actual business structures. Rather, they are a tax status that can be elected by members in order to avoid the double taxation of C corporations. This special tax status allows members to be individually taxed based on the amount of the gain/ loss in the period divided by their respective ownership stakes in the company. Because pass (flow) through entities create a separation between owners and the business, owners cannot be considered employees and therefore must claim earnings as self-employment income. Owners will likely then be subject to different tax rates depending on their portion of ownership in the company and which tax bracket their amount of income falls into.

Pros:

• Pass through taxation
• 20% qualified income business deduction - The Tax Cuts and Jobs Act of 2017 gave eligible S Corp shareholders a deduction of up to 20% of net “qualified business income”.

Cons:

• Only able to issue one class of stock
• Limited to 100 shareholders
• Tax must be paid on business' income as if all of that period's income were to be distributed, regardless of whether or not it was.
• Must be a domestic company
• Shareholders must be permanent/ legal residents of the U.S.

Ideal Conditions:

• Generally it is a good idea to file under an S-Corporation if the owner(s) are not planning an IPO and do not want more than 100 shareholders.
• Distributions are expected to be frequent and large
• Do not plan on offering preferred stock
• Shareholder's total personal tax liability will be lower if using pass through system rather than entity taxation
• You will have losses to deduct from personal income tax.

Some commentators have recommended an LLC taxed as a S-corporation as the best possible small business structure. It combines the simplicity and flexibility of an LLC with the tax benefits of an S-corporation (self-employment tax savings).

Some legal scholars argue that corporate income taxes are intended to limit the power of corporations and to offset the legal benefits corporations enjoy, such as limited liability for their investors. There is concern that LLCs, by combining limited liability with no entity-level taxation, could contribute to excessive risk-taking and harm to third parties.