Limited liability companies (LLCs) are unique business entities that offer owners flexibility in taxation. LLC owners, known as members, have options when it comes to tax treatment. LLC owners can elect to be taxed like a sole proprietorship/partnership or they can elect to be taxed like a corporation. How the members elect the IRS to tax them dictates what form they must file with the IRS.
Sole proprietorships and partnerships are unincorporated business entities. As such, they do not have a separate legal identity from the owners. Accordingly, owners of these types of business entities get taxed personally on the profits and income they make from their businesses. This form of taxation is referred to as “flow through” taxation. A corporation, on the other hand, is considered a separate legal entity with its own independent existence from its owners. Therefore, a corporation gets taxed on profits it makes in addition to the shareholders who get taxed again for any income or profit they make from the corporation.
Read More: Tax Differences Between an LLC & a Sole Proprietorship
The IRS presumes an LLC wants flow through taxation. That means a single member LLC gets sole proprietorship tax treatment while a multi-member LLC gets taxed like a partnership. However, in the event the members want corporation tax treatment, they can elect this option by filing IRS Form 8832. The members must all sign the form. Members can use Form 8832 to elect what tax treatment they want and also change their existing tax treatment such as from a partnership to a corporation. If the LLC chooses to file as a corporation, it generally must file Form 1120, U.S. Corporation Income Tax Return.
A single member LLC can elect to be taxed like a sole proprietorship. In that case, the single member reports all net income and losses of the LLC on her personal tax return. Generally, the form that the member must file is IRS Form 1040 Schedule C. However, different types of income may require the member to file a different schedule. Real estate rent and royalties income require Schedule E. Farming income requires Schedule F. In addition, the member must file Schedule SE, which is used for self-employment tax.
If a multi-member LLC does not elect corporation taxation, it must file like a partnership. The appropriate form for partnerships is IRS Form 1065, which reports the assets and transactions of the LLC and calculates each member's income from the business. The LLC must provide each member a Schedule K-1 (Form 1065-B), which is like a W-2 for partnerships. Each Form 1065-B must be attached to the 1065 return. If the LLC has non-member employees, then it must collect W-4 forms from employees and issue W-2’s for all employees’ wages, salaries and tips. Any non-regular employees, like independent contractors, must get a 1099 from the LLC.
An attorney and founder of ScrofanoLaw, a general practice law firm in Washington, D.C., Joseph Scrofano has been writing on legal issues since 2008. He holds a Juris Doctor from the Washington College of Law, a Bachelor of Arts with special honors from the University of Texas and a master's degree in international affairs from American University's School of International Service.