S Corporation Tax Status for Your LLC

Yes, an LLC can elect to be taxed similar to an S corporation. You may question, why you would even want this type of tax treament? Read on and I'll explain.

Owners or members of an LLC have the option to choose the form of tax treatment they will receive. However, this was not always the case. In the past, the Internal Revenue Service (IRS) classified business entities as either partnerships or corporations based on four different factors.

The four factors included: (1) Limited liability; (2) Centralized management; (3) Continuity of life; and (4) Free transferability of interest. A business entity would be taxed as a partnership if it possessed two of the four characteristics. It would likely be taxed as a corporaiton if it possessed three of the four characteristics. This led to a lot of confusion and uncertainty for business owners.

Then in 1997, new IRS regulations came into effect which allowed business entities like LLCs to elect the tax treatment they desired. These regulations became known as the "check-the-box" regulations. They can be found in Income Tax Regulations 301.7701-1 through 301.7701-3. Details about making the election are set forth in the IRS instructions to Form 8832.

The change in the law offers different choices to entities such as an LLC. It will allow a business operated as an LLC to enjoy all of the beneficial characteristics of a corporation but still be taxed as partnership or, in the alternative, it provides for an LLC to elect corporation tax status and then make the S corporation election.

In a nutshell, partnership taxation is a form of pass through taxation where the the income and deductions "flow through" the entity and are reported and paid by the individual partners. Most LLCs and S corporations are taxed this way. On the other hand, if an entity is considered a corporation, it will have to pay income taxes on its net profits and then when those proceeds are paid to the shareholders in the form of dividends, they will have to pay tax again at their personal level. This is called the "double tax" of corporations.

Most small businesses can avoid this double taxation either by forming an LLC or electing S corporation status. LLCs by default receive partnership taxation. This means if the owners do not make an election by filing Form 8832 to be taxed as something different than a partnership the LLC and its members will automatically be subject to partnership taxation principles. A corporation which makes the S election is also subject to the basic partnership taxation principles with a few exceptions. Both LLCs and S corporations are considered pass through entities for tax purposes and are subject, with a few exceptions, to the partnership form of taxation.

Most tax advisors and accountants professionals suggest that a business owner can reduce (not eliminate) the FICA or 15.3% self employment tax by forming a corporation and making the S election. However, this same treatment is not available in most cases to the members of an LLC, unless they make the election to be taxed as a corporation by filing IRS Form 8832 and then make the S election by filing IRS Form 2553. This procedure allows the LLC to obtain reduced FICA tax treatment for its members while operating with the less formal structure and rules associated with corporations.

Setting up an LLC which elects tax treatment similar to the S corporation, may be an attractive option to discuss with your accountant or tax advisor. In addition to being able to operate under the less formal requirements of an LLC, you get limited liability protection, basic partnership taxation, with a few exceptions, and the chance to reduce FICA taxes for the members of the LLC.

Article Source: http://www.articles.ask-me-about.com

Attorney Robert Montgomery offers valuable resources for your LLC saving tax money create LLC (LLC)