Tuesday, July 5, 2016

When LLCs Can Be Corporations (For Tax Purposes Only)

So, readers of this blog know that I despise the misuse of the term "limited liability corporation" when the writer or speaker means "limited liability company," which is the correct term for an LLC.  There is a time, though, when an LLC can be a corporation, and that is for federal tax purposes if the entity makes such a choice.  

Entity choice is a state law decision, but and LLC can elect to be treated as a corporation under the Internal Revenue Code. The Internal Revenue Service recently issued Publication 3402, which explains: 

Classification of an LLC Default classification.

An LLC with at least two members is classified as a partnership for  federal income tax purposes. An LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes). Also, an LLC's federal tax classification can subsequently change under certain default rules discussed later.

Elected classification.

An LLC can elect to be classified as an association taxable as a corporation or as an S corporation. After an LLC has determined its federal tax classification, it can later elect to change that classification. For details, see Subsequent Elections, later. LLCs Classified as Partnerships If an LLC has at least two members and is classified as a partnership, it generally must file Form 1065, U.S. Return of Partnership Income. Generally, an LLC classified as a partnership is subject to the same filing and reporting requirements as partnerships. See the Instructions for Form 1065 for rep

Still, this should really be called an LLC that has elected federal tax status as a corporation or an "LLC FCorp." Or something like that. But at least in this situation, an LLC is something of a corporation.  

https://lawprofessors.typepad.com/business_law/2016/07/when-llcs-can-be-corporations-for-tax-purposes-only.html

Corporations, Joshua P. Fershee, LLCs | Permalink

Comments

Yeah, but ...

Not only may an LLC elect to be taxed as a corporation, but so may a partnership (whether or not an LLP) or a limited partnership (whether or not an LLLP). Assuming we don't want to create the "limited partnership corporation," or worse yet the "limited liability limited partnership corporation," I'd suggest we leave tax classification out of it.

TER

Posted by: Tom Rutledge | Jul 5, 2016 11:47:06 AM

In 20 years of practice, understanding the tax flexibility, I am not familiar with an LLC that elected sub S status. I've wrestled with why one would choose an S election in an LLC and posed it to colleagues and tax academics. No one has sufficiently answered the question.

Posted by: Tom N. | Jul 6, 2016 10:07:05 AM

Tom N.
LLCs taxed as a S-Corp have a few advantages over a Corporation electing Sub-S status.
LLCs have fewer annual formalities to follow and can be simpler/cheaper to form.
Traditionally in the small business world a taxpayer can form a LLC and if it only has one member the IRS will treat it as “disregarded” and all activity will be reported on the members schedule C on their 1040. When the LLC business grows to a certain point where a S-election makes sense then the taxpayer can make a S-election the year of, before March 15th and be treated as a S-Corp for IRS purposes going forward.
Additionally if the sole member adds a new member the default treatment is a partnership at that point.

Summarizing LLC gives the taxpayer more flexibility from day one and going forward for IRS purposes and growth of the business.
LLCs also have the charging order remedy with judgement creditors.
Corporation judgement creditors can sometimes execute on the shares of the Corporation.

Posted by: John K | Jul 6, 2016 8:55:33 PM

John. Thanks for your comments. Aware of distinction between charging orders (which is a patchwork of disparity throughout most jurisdictions simply adopting uniform acts) and levy and sale of stock. You might want to follow Jay Adkisson (contributor to Forbes) on the patchwork quilt of actual effect of charging orders. Also, you may be aware of recent IRS rules that disallows treatment of members, despite C or S election as SE. See: http://www.bpbcpa.com/business-consulting-and-planning/irs-rules-partners-not-employees-disregarded-entities-angie-adames-cpa/

Posted by: Tom N. | Jul 7, 2016 6:27:05 AM

John. Let me correct above typo. IRS Rules prohibit treatment of members of uncorporations making C or S elections as employees and mandating SE.

Posted by: Tom N. | Jul 7, 2016 6:28:36 AM

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