The Limited Liability Company or LLC is a legal entity formed with the state. Once formed, taxpayers have the ability to determine how the LLC is taxed for Federal income tax purposes. This presents a number of issues that have to be considered for LLC owners.
Income Taxes & LLCs
The IRS regards a single member LLC (i.e, a LLC owned by one individual or entity) as not being a separate taxable entity distinct from the owner. As a disregarded entity, the sole owner of the LLC can simply account for the profits and losses of the LLC on the taxpayer’s personal tax returns (on the Schedule C included on the taxpayer’s personal income tax return).
If the LLC has more than one owner, the default classification is a partnership. The partnership files its own tax return, but the return does not report tax–the return merely computes the income and expense and divides those among the partners. The partners then report the net items on their personal income tax returns.
The check-the-box regulations allow taxpayers to change these default classifications. Taxpayers can opt to have the LLC taxed as a C corporation or S corporation. The C corporation pays tax at the entity level and the S corporation is taxed similar to partnerships, described above.
What About Employment Taxes for LLCs?
Sole proprietorships (taxed as disregarded entities) and partnerships do not pay employment taxes. C and S corporations do.
The rules recently changed regarding who is liable for these taxes. The sole owner of a single member LLC is personally liable for employment taxes related to the LLC’s employees.
The IRS has the ability to impose a lien or levy or seize the sole owner’s personal assets if the LLC’s employment taxes are not paid, but the IRS cannot levy or seize the LLC’s assets to satisfy this type of liability. This is true regardless of whether the sole owner elected to use his or her name and social security number for the LLC tax reporting or if the sole owner elected to use the LLC name and a separate taxpayer identification number for the LLC tax reporting.
The result for the multi-member LLC (i.e., a LLC owned by more than one individual or entity) may be different depending on the applicable state law. If the state law provides that members of LLC’s are not liable for LLC debts then the IRS’s recourse with regard to the LLC’s unpaid employment taxes lies with the LLC and not with the member owner.
Given this dichotomy it may make sense for single member LLC owners to convert their single member LLCs into multi-member LLCs or to elect to have the LLC be taxed as a C or S corporation once the LLC has achieved some measure of financial success. Of course, the business owner must also consider other tax factors, such as the trust fund recovery penalty and the role of self-employment taxes.