By Alfred Fricano
You’ve taken the leap and started your own business. You might already have a business name, a product line or list of services and office supplies. But before you put out the “Open” sign, you need to take care of one of the most important things: the paperwork.
Choosing to organize your enterprise as an LLC, an S Corp, or a combination of the two will have legal and tax implications. In Part 2 of this four-part blog series, we’ll look at the pros and cons of becoming an LLC.
LLC Offers Limited Liability and Flexibility
An LLC, or a Limited Liability Company, is a business structure authorized by state statutes. It is a structure designed to provide the limited liability features of a corporation along with the tax efficiencies and operational flexibility of a sole-proprietorship or a general partnership.
As a pass-through entity (unless it chooses tax treatment as a corporation), all of an LLC's profits and losses pass through the LLC to its owner(s), known as member(s). As with a proprietorship or partnership, each individual member reports the profits and losses on his or her federal tax return. This avoids the double taxation to which a regular corporation and its owners are subjected.
However, the LLC still provides a limit on the personal liability of its member(s) in much the same way a corporation does. Typically, a member's personal liability is limited to his or her investment in the LLC.
This feature distinguishes the LLC from a sole proprietorship or general partnership, in which each owner is subject to liability for all of the debts of the business.
Features of an LLC
The features of an LLC may make it an excellent choice of structure for your new business enterprise. The following summarizes the most significant features of the LLC:
Serves as a pass-through of income to owners, avoiding double taxation (unless corporate treatment is elected)
Ease of operation - fewer filings, forms, start-up costs, formal meetings and record keeping requirements
Fewer profit-sharing restrictions - earnings distributed as members see fit; not based on percentage of capital contributions
Entire net earnings of LLC passes through to owners in the form of self-employment income subject to 15.3 percent SECA tax (self-employment tax for Social Security and Medicare).
Tax Classification for LLCs
The IRS does not recognize the LLC as a taxpayer classification for federal tax purposes. Federal tax treatment is separate and distinct from the limited liability provided to members under state law. Whether an LLC is treated for federal tax purposes as a sole proprietorship, a partnership or a corporation, the members are still shielded from liability.
For tax purposes, by default, an LLC with one member is treated as a sole proprietorship. By default, LLCs with more than one member are treated as partnerships. However, an LLC can elect to be treated as an association taxable as a corporation by filing Form 8832, Entity Classification Election.
Once it has elected to be taxed as a corporation, an LLC can file a Form 2553, Election by a Small Business Corporation, to elect tax treatment as an S corporation.
If you’re starting a new business or are interested in more information about how your business can benefit from forming an LLC, contact our office.
In Part 3 of this series, we’ll discuss the advantages and disadvantages of organizing as an S Corporation.