How is Your LLC Taxed?

There is a lot of confusion as to the taxation of an LLC (limited liability company).  The LLC does not have its own “tax structure” under the IRS code.  Corporations and partnerships have their own tax structures.

In a partnership, partners divide up the profits and losses based on their percentage ownership of the partnership, and they pay their own taxes.  The company gives all of the partners a K-1 telling them what their share of the profit or loss is.

Corporations actually have a two choice system.  If you have a corporation, you can be taxed under subchapter C of the IRS code or you can be taxed under subchapter S of the IRS code.  You get to choose which code section you want to be taxed under.

Subchapter C of the IRS code taxes the traditional corporation like IBM, Bank of America, and all the big boys.  The corporation pays its own taxes directly to the IRS.  Subchapter S of the IRS code taxes the corporation about like a partnership would be taxed.  The S corporation has to file a tax return, but then the actual earnings or losses “pass through” on a K-1 to the owners of the corporation and are actually “recognized” by the owners pro-rata based on their ownership interests.

An LLC is not a partnership or a corporation.  It is a unique business structure called a limited liability company.  The confusion comes in the taxation.  So just how is your LLC taxed? Because the LLC is actually a defective corporation, the IRS didn’t know whether or not to tax it as a corporation.  But, it’s not a partnership, so it couldn’t be taxed as a partnership.  When it was first created in Wyoming, the people who were pushing the Wyoming legislation asked how the IRS wanted it taxed. It took almost 20 years for the IRS to give the answer.  The IRS could have created another section of the code describing specific taxation rules for the LLC, but they didn’t.  The IRS simply said that they would let the LLC decide how it wants to be taxed.

If there is only one owner, you can do nothing, and the LLC will be taxed as a sole proprietorship.  If there is more than one owner, it can be taxed as a partnership.  You can have your LLC taxed as a corporation (either C or S), if you file the appropriate papers with the IRS.  You can be a single member (one owner) LLC and still make the election to be taxed as a corporation.  The bottom line is, you choose how you want your LLC to be taxed.

Your LLC is the same animal, has the same asset protection strength, operates the same, and everything is the same with your LLC, independent of how your LLC files taxes.  To put it another way, the legal structure of your LLC is the same no matter what tax structure you choose.  There is no such thing as a limited liability partnership, or a limited liability corporation.  There is only a limited liability company taxed as either a partnership or corporation.

As I mentioned, an LLC is basically a defective corporation.  And you get to choose how it is defective and how is your LLC taxed.  In the standard internet forms, and even the standard law office forms, the assumption is made for you as to how you want your LLC to read.  You can play tricks with the LLC by making it defective in different ways.  My new course, Maximizing Your LLC’s Money Making and Asset Protection Potential, shows you the tricks.   It will teach you everything about the tax benefits and asset protection of an LLC, from setting it up in your own state, to doing the tax stuff, to getting the maximum asset protection.  If you don’t make more than what you pay for it in the first year using the tips I give you, I’ll refund your money – less credit card fees.

Hope this helps clear a little of the air.

By Lee R. Phillips