10.20.09
BTW: No LLC at IRS
“The IRS doesn’t recognize limited liability companies.” I’ve told clients that a hundred times, and it almost always evokes a blank stare, so I’m going to try to summarize the reality here.
The Technical Background. The Internal Revenue Code is divided into Subtitles. The Subtitles are then broken down into Chapters, and each Chapter is further broken down into Subchapters (which are then broken down into Parts, then Subparts, and then Sections). Subtitle A deals with “Income Taxes.” Chapter 1 deals with “Normal Taxes and Surtaxes.” Among Chapter 1’s Subchapters are “Corporations” (C), “Exempt Organizations” (F), “Partnerships” (K), “S Corporations” (S). There is no Subchapter for limited liability companies. That’s what tax planners mean when they say “The IRS doesn’t recognize limited liability companies.” Although the IRS certainly realizes that LLCs exist and have even modified their forms somewhat to reflect that many taxpayers are limited liability companies, there is no designated tax treatment for them.
What It Means. It’s a good thing. Because the IRS doesn’t recognize LLCs, you can select whatever tax designation you want. If you’re a one-person LLC, you can select C corporation, S corporation, or nothing (referred to as a “disregarded entity,” which means your profits/losses from your business will go on Schedules C, E, or F of your IRS Form 1040). If your LLC has two or more people, you can be a partnership, C corporation, or S corporation.
How to Decide What to Be. You need to talk with your attorney or accountant to determine how your LLC should be taxed to maximize post-tax profits. If you don’t make any elections, a one-person LLC will be taxed as a disregarded entity, and a two-person entity will be taxed as a partnership. Those are the defaults. As a practical matter, most clients want their LLCs to be taxed as S corporations, but that’s not always the best choice. Fringe benefit issues, self-employment taxes, and entity flexibility are just a few of the things that play into the final decision.
