How is a Limited Liability Company (LLC) taxed?
Posted: Aug 26, 2018
Definition: A limited liability company is a business structure widely known in the US in which the member(s) is only liable to the company’s debts up to the value of available assets of the business. In a limited liability company, the owner(s)’s personal property does not get affected if the company goes bankrupt or if the owner(s) fails to pay the debts.
A limited liability company incorporates the combined characteristics of a corporation and a sole proprietorship or a partnership firm. The element of limited liability is similar to a corporation’s liability while not being separately taxed is a feature of sole proprietorship and partnership.
How is a limited liability company taxed?
The Internal Revenue Service (IRS) calls limited liability company a ‘pass-through’ entity, which means it is not a separate tax entity. All the members report the profit and loss details on their personal tax returns, the company does not separately pay any taxes. The number of members of the LLC decides whether the IRS considers it a sole proprietorship or a partnership.
Single member limited liability company
Single Member Limited Liability Company (SMLLC) is considered as a disregarded entity – an entity which is not recognized for tax purposes by the IRS, separate from its owner. The owner has to fill the IRS Schedule C form, report the profits and losses on personal income tax return and has to file it with 1040 tax return. If the owner of an LLC leaves the profits in the company’s bank account for any unforeseen event, even then he would have to pay income tax on that amount at the year-end. An LLC may, however, elect itself as a corporation. In that case, the owner would be required to file a separate tax return instead of continuing to self-employment income on Schedule C.
Multiple members limited liability company
The IRS treats Multiple Members Limited Liability Company (MMLLC) as a partnership firm for federal tax purposes. The tax is spread among the members as in the partnership. The company does not separately pay the tax but each owner pays it according to their profit sharing ratio. The profit and loss sharing is mentioned in the Limited Liability Company Operating Agreement. Though this agreement is not a legal obligation, it forms the base for financial of the LLC. As a partnership files return, MMLLC would also have to file the tax return on the form 1065 with the IRS. The MMLLC also gives a Schedule K-1 to each member, this form depicts the income and deductions of each member of the limited liability company.
If the limited liability company is elected as a corporation, then it should file form 1120. If you want it to be taxed as an S-Corporation then it should complete form 2553, and if it wants to be taxed as a C-Corporation then is should complete form 8832. It should be noted that an MMLLC is not truly a partnership firm, the IRS considers it so just for the federal taxation purposes.
Just as the taxation requires a thorough knowledge of the structure of an LLC, the formation also needs few essential checkboxes to be ticked in order to minimize the legal complications.
The name of your LLC
The selection of a name is a basic but absolutely crucial part in the formation of an LLC. The owner(s) must consider few elements while choosing a name for an LLC;
- The name must not be a duplicate one or must not be the same as any other already existing company. The name of an LLC must be an available one.
- The term ‘LLC’ or ‘Limited Liability Company’ must be attached to the name to make it clear that your company is a limited liability company. This requirement is laid by most of the states as a general rule for naming your company. Therefore, a limited liability company must comply with it to carry out the operations smoothly.
- The name must not include any words that are prohibited by the state’s law. For instance, in some states, the words ‘Bank’, ‘Corporation’, and ‘Insurance’ are prohibited.
Articles of Organization
The owner(s) needs to draft the Articles of Organization for a limited liability company and file it. This is a document which includes all the key information related to an LLC, like;
- The name of the company
- The primary address of the company
- The purpose for the formation of the LLC
- The operational duration of the company
- Details of the management (if hired)
- The name and address of the LLC’s registered agent
An Operating Agreement may or may not be required by your state’s law but its creation lays down a set of rules to be followed by the member(s) and the management. An Operating Agreement assists in controlling and organizing a limited liability company in the long run, it enlists;
- Rights and responsibilities of the owner(s)/member(s)
- The percentage of interest each member is entitled to receive
- The allocation of profit and loss sharing ratio among the members
- The regulations relating to how the LLC would be managed
- The rules relating to the voting and voting power of the members
- The rules for continuity if any of the members wishes to leave the LLC, develops an unsound mental state or dies.
Hey, it is Steve Marshall - The Content Writer - You may contact me at Marketing@mayabytes.com