Tax Treatment of Limited Liability Company

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Tax Treatment

LLCs enjoy very favourable tax treatment. They don't have their own set of tax rules and there's no such thing as an LLC tax return. What makes them special is that members can choose how the business is taxed.

A single member LLC can choose to be taxed as a:

• Sole proprietor
• S corporation, or
• C corporation

A multiple-member LLC can choose to be taxed as a:

• Partnership
• S corporation, or
• C corporation


By default LLCs are pass-through entities and taxed like sole proprietors or partnerships. In other words, the profits or losses of the business flow through to the members personal tax returns.

A single-member LLC must complete Schedule C, just like any other sole proprietor, and multiple member LLCs must complete Form 1065, just like a partnership.

You can elect for your LLC to be taxed as a C corporation by completing Form 8832 with the IRS. Alternatively, you can complete Form 2553 and elect for your LLC to be taxed as an S corporation. The business still remains an LLC, all that changes is the tax treatment.

Many tax pros say it's best to have the LLC taxed as a sole proprietorship or partnership in the early years when profits are small or there are losses. Losses flow straight through to your personal tax return and can offset other income.

Later on, when the business is more profitable, it may be a good idea to elect for corporate tax treatment so that some surplus profits kept in the business can be taxed at the 15% corporate tax rate. This is known as income splitting.

LLCs that can benefit from corporate tax treatment often go the whole nine yards and incorporate so as to enjoy other benefits unique to corporations, such as access to outside investors and employee stock options.

Converting an LLC to a corporation is a non-taxable event.

State Tax Treatment - S Corp Vs C Corp

The tax treatment of LLCs (and corporations, for that matter) varies considerably from state to state. Some have much lower taxes than others. For example, Nevada doesn't levy any income tax on individuals or corporations

You can set up your LLC in any state you like, so is it a good idea to pick a state with very low taxes?

The answer is NO because if a business owns property, employs people or makes sales in any state it generally owes taxes in that state.

So if you form an LLC in Nevada but do all your business in California, you will still have to pay California state income tax.

And if you fail to register in your home state you could face heavy penalties. For example, in Indiana an LLC formed in another state faces a penalty of up to $10,000 if it does business in Indiana without a certificate of authority.

So why is Nevada so popular with people setting up LLCs and corporations? The main legitimate reason is for the extra liability protection available in that state.

The important point is this:
Do not set up your LLC or corporation in another state just to save tax.

You'll find more information on s vs c corp and llc vs s corp on Taxcafe.com

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