Should I Elect to Have My LLC Taxed as a Corporation?
The limited liability company (LLC) form of business is the newest invention in business forms. It's also the most flexible, especially when it comes to taxes. An LLC can be taxed in several different ways to save on taxes for the business and its owner.
In this article, we'll look at the LLC form of business, how an LLC is usually taxed, how being taxed as a corporation can be of benefit to the business, and the process of electing this tax option.
Should You Elect to Have Your LLC Taxed as a Corporation?
An LLC may elect to be taxed as a corporation, instead of a partnership or sole proprietorship. Since many tax advisers extol the advantages of the LLC form of business, why would an LLC want to be taxed as a corporation?
How LLCs Are Taxed
By default, if you do not elect otherwise, your LLC is taxed in one of two ways, depending on how many owners members are in the LLC:
- A single-member LLC is considered a disregarded entity and is taxed as a sole proprietorship, filing Schedule C for the individual's personal tax return.
- A multiple-member LLC is taxed as a partnership. The partnership files an information return on Form 1065, with Schedule K-1's for each member/partner.
These tax situations are what the IRS calls the "default" for income tax for an LLC. But there are other tax options for an LLC, as noted above. One of these options is for the LLC to be taxed as a corporation.
The Advantage of the Election to Be Taxed as a Corporation
Usually, businesses select the tax form that will yield the lowest taxes. The personal tax rate (for sole proprietorships and partnerships) at the high end of the tax tables is higher than the highest corporate rate, so if your total taxable income (aka adjusted gross income), including your LLC net income, is very high, you might want to remove your business from being included in your personal taxes. Having the LLC taxed as a corporation does this.
The main advantage of having an LLC taxed as a corporation is the benefit to the owner of not having to take all of the business income on your personal tax return. Let's look at a scenario:
Your LLC has a net profit of $50,000 for the year. If you are the only owner of the LLC, you must take all of this profit on your personal income tax return. If you have the LLC taxed as a corporation, you can retain some or all of the profit (keep it in the business) and not pay personal income tax on this profit.
The Disadvantage of the Election to Be Taxed as a Corporation
One big advantage of an LLC is that owners avoid double taxation — paying taxes on the income of the corporation and also on income received as dividends. If you decide to have your LLC taxed as a corporation, you (as the owner) will be subject to this double tax situation. Going to the corporate form means you will be subject to double taxation, so the decreased tax had better be significant.
Before you make any decisions regarding your LLC taxes, including this election, spend some time working out "what if" scenarios with your CPA and/or tax professional. Be sure you are making your decision based on reasonable knowledge of the future (as much as any of us can know it).
How to Make the Election
If you decide to make this election, here is some more information you need to know:
- The election is made on IRS Form 8832 — Entity Classification Election.
- The form allows "eligible entities" to file this election. LLCs are specifically stated to be eligible entities.
- An LLC files this election to be an "association." The IRS uses the term "association" to mean "an eligible entity taxable as a corporation by-election..."
- The form includes a consent statement which may be signed by all members, or by one member on behalf of all members. If one member signs, there should be some record in company membership meetings that all members approved this election.
What Happens to the Old Entity
When your election to corporate status becomes effective, the IRS determines that all the assets and liabilities of the previous business (sole proprietorship or partnership) are contributed to the corporation in exchange for shares of corporate stock.
When to File the Entity Election
The election to be taxed as the new entity will be in effect on the date entered on line 8 of Form 8832. The election cannot take effect more than 75 days before the date the election is filed, nor can it take effect later than 12 months after the date the election is filed.
Disclaimer: This information is provided to give you a general knowledge of the subject and to allow you to have information to discuss with your attorney, CPA, or tax adviser. I am not a CPA, tax attorney, or Enrolled Agent, and I do not give tax or legal advice. Every business situation is unique, and taxes and laws change regularly. Consult with a tax professional and attorney before making any decisions that could affect your business.