Is Your LLC Giving Your Money to the IRS? (Part 2)

Welcome to Part 2 of our LLC series blog, “Is Your LLC Giving Your Money to the IRS? “.

In Part I, we discovered that, for tax purposes, the LLC business structure is not recognized by the Internal Revenue Service and that choosing the right legal structure for your business could easily save you thousands or tens of thousands of extra tax dollars.

For Part 2, we would like to focus more on how an LLC is taxed.

For this, we need to look at four of the major business models because the LLC taxation follows a model of one of these entity types. Let’s discuss how that works:

Disregarded Entity

When you are the only member of an LLC, by default, your business will be taxed as a Disregarded Entity. This literally means that for tax purposes, the IRS ignores the fact that the business entity exists, and it is taxed in the same manner as if there was no LLC formation.

For a single member, this results in being taxed as a sole proprietorship, which is taxed directly to the owner on their personal federal tax return on Form 1040.

Partnership:

If two Members own the LLC, by default, your business will be taxed the same as a partnership. With a partnership, the income is passed through to all partners’ individual 1040 federal tax form via Form K-1 and taxed whether or not the funds are distributed.  

C – Corporation

It is possible to petition the IRS for a special taxation consideration asking to be taxed the same as if your business was a corporation. There are very specific issues that need to be addressed prior to making this selection. Once the IRS approves this election, your business will now be treated as a C-Corporation.

In the right business strategy, a C-corporation can be advantageous, but you need to know what you are doing to utilize this properly. 

It can also have disadvantages for many.  A C-corporation tax election will subject you to the “double taxation” situation that faces a corporation, being taxed as a corporation, and then again when monies are paid to shareholders as dividends.

S – Corporation

Once your LLC is approved by the IRS to be taxed as a C-Corporation (all corporations start as a C-corp), you may further elect it to be taxed as an S-Corporation.

This means instead of being taxed as a C-Corp, your income is passed through to the shareholder’s federal tax return on Form 1040 via Form K-1 similar to the partnership structure whether or not the funds are distributed.

This flexibility of taxation is both a blessing and the curse of the LLC.

All entities have advantages and disadvantages. These pros and cons in their implementation can be used to your advantage.

An LLCs greatest strength and weakness is the way it is taxed. Having a good business strategist that understands this can help you select the right entity structure or combination of business structures that can literally save you thousands – and not uncommonly tens of thousands – of dollars, when postured to the best advantage for your individual situation. The wrong structure can be your financial downfall.

As a responsible business owner choosing to educate yourself and make some right choices, watch for the upcoming Part 3 of this LLC bog series, “Is Your LLC Giving Your Money to the IRS?” to expand your understanding of the unique structure of the LLC.

Business Untangled offers mentorship on proper business structuring. Whether you choose an entire Business Tax Blueprint or a consultation focused on a specific situation, it is an investment that will pay off handsomely both financially and with less stress. 

Our first discussion is free – call today!