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LLC Tax Election

An LLC tax election is the decision you make to determine how your LLC is taxed. An LLC is a unique LLC Tax Electionbusiness structure called a limited liability company, but the IRS Code has not given the LLC a unique taxation section. So how is the LLC to be taxed? It is taxed by something called an LLC tax election.

Most business entities such as corporations and partnerships have their own tax structures under the tax code. However, an LLC does not have its own tax structure under the IRS code. When it was first created in Wyoming, the legislature asked the IRS how they wanted it taxed. The LLC is not a Partnership; it is organized as a defective corporation. As a result, the IRS didn’t know whether or not to tax it as a partnership or a corporation.

LLC Taxation Rules

It took over 20 years for the IRS to give the answer. The IRS could have created another code section describing specific taxation rules for the LLC, but they didn’t. The IRS decided to let the LLC owners choose how they wanted it to be taxed.  Publication 3402 outlines this decision. If you are wondering how to plan for your LLC tax election, look at your LLC and consider why you have the company, what it does, and who is involved. Then you need to understand the different election choices.  These video explains the choices:

In a partnership, the tax code directs the partners to divide the profits and losses based on their percentage ownership of the partnership. The company then gives all of the partners a K-1 form telling them what their share of the profit or loss is. The partners then pay taxes on the gain.

The IRS Code gives corporations two separate tax choices. A corporation can be taxed under subchapter C of the IRS code or it can be taxed under subchapter S of the IRS code. Owners get to choose which code section they want to be taxed under.

Corporation Taxation Options

Generally, corporations like IBM, Bank of America, and all the big boys chose to be taxed under subchapter C of the IRS Code. Under this subchapter C, the corporation pays its own taxes directly to the IRS. The owners then pay taxes on their wages. Smaller corporations chose to be taxes under subchapter S of the tax code. Under subchapter S the corporation is taxed 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. The profits are actually “recognized” by the owners pro-rata based on their ownership interests.

So what should the LLC owner do? If the owner does nothing and there is only one owner, the LLC will be taxed as a sole proprietorship. If there is more than one owner, it can be taxed as a partnership. The LLC owner can make an LLC tax election to have the LLC taxed as a corporation (either C or S). To make an LLC tax election the owner simply must file the appropriate papers with the IRS. What’s the bottom line? The LLC owner can choose how the LLC is taxed. The LLC Wizard has a LCC decision chart and audio instructions to help someone make the proper IRS election.

LLC Asset Protection

No matter what LLC tax election is picked, the LLC will have the same asset protection strength, and will operate the same. 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. An important thing to remember is that your little company is your best tax saver. If you are interested in saving taxes, look at my 10 Tax Tips. I hope this information is helpful.

Lee R. Phillips

 

5 Comments
  1. I’m a Real Estate Agent with Earned income from commissions and payments for services but I also own a house with my husband that is a rental property. My husband is not a member of the LLC but my son is with a 20% ownership.
    Which option should I choose for taxation? S-Corp or Partnership?

    Thank you for your help.

  2. The ideal situation is to have your real estate business as an S Corp and your rental property in a separate business as a partnership. If you are going to own everything in one business you would want to talk to an accountant who can determine which is better based on your particular circumstances.

  3. Dear Sir,

    First of all, all of your videos are fantastic.
    I couldnt find your contact email, hence writing to you here.
    I am planning to start a Delaware LLC, and before doing so would like to know what taxes I will have to pay at Federal and State level (or any other taxes/fees etc within the US for that matter).
    I am a US non-resident alien, providing services/products to clientele outside the U.S (mostly within the CIS region).
    My main business, at this point, is making and selling websites, providing email marketing services, online commerce, logo making, general branding and other related services. I use online services like Wix.com (Israeli company), Gmail (a US company) and Madmimi.com (a US company) to provide my services/products, and am not sure if that would constitute a US source of income and be taxable.
    Will I have to pay taxes in the US?
    What tax election would you recommend for my LLC?
    Would you be able to provide advice in this regard? I am willing
    Thank you!

  4. Serdar,
    If you don’t live in the US and you don’t make your money in the US then you don’t need to pay taxes in the US. Forming an LLC in the US will just make it so you do have to pay taxes here.

  5. Serdar,
    If you form an LLC in Deleware you will pay taxes in the US because your LLC will be considered to do business in the US.
    You won’t have much of a choice for tax election. You have to be a US citizen or Resident Alien to be a S-Corp so your only options are sole proprietor if you are a single member LLC or partnership if you are a multi-member LLC.

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