A limited liability company, or LLC, is a form of business structure authorized by state law. An LLC is not a business entity recognized by the Internal Revenue Service for tax purposes. Rather, an LLC must elect to be taxed as one of the business entities classified by the IRS. LLCs owned by a single member may elect to be taxed as a corporation or sole proprietorship disregarded entity, which conveys significant tax advantages.
Taxation Entity Election
A single-member LLC will be taxed as a sole proprietorship disregarded entity under IRS default rules, unless the LLC owner chooses to be taxed as a corporation. A single-member LLC owner can elect to be taxed as a corporation by filing IRS Form 8823, Entity Classification Election. Once the election is made to change the LLC's tax status from sole proprietorship to corporation, it cannot be changed again for five years. The owner of an LLC maintaining sole proprietorship tax status has liability protection akin to that offered by a corporation, but with the tax benefits of a disregarded tax entity.
Simplified Tax Filings
A single-member LLC taxed as a sole proprietorship does not have to file a separate business tax return. LLC income and expenses are reported on Schedule C of the owner's Form 1040 individual income tax return. By avoiding the complexity of filing a corporate return, a sole proprietor can save hundreds or even thousands of dollars in tax return preparation costs.
Avoid Double Taxation
Electing to be taxed as a sole proprietorship avoids the double taxation that would result if the LLC were taxed as a corporation. Under a traditional corporate business structure, or with an LLC that elects to be taxed as a corporation, the business will be subject to double taxation: Business proceeds are taxed first at the corporate level as corporate income, then at the personal level as income to the individual working for the corporation. A single-member LLC opting to be taxed as a sole proprietorship is a disregarded entity that enjoys pass-through taxation; that is, business income taxed only once at the personal income level.
Read More: LLC Pass Through Taxation
Single member LLCs that do not elect to be taxed as corporations may take advantage of additional tax benefits available only to sole proprietorships. One of these advantages is that a sole proprietor can employ her minor children without paying any payroll tax. Hiring your teenager and paying him wages rather than taking in the money as personal income and paying the teenager an allowance can increase the net family income and lower the family's tax liability significantly. Another unique sole proprietorship tax advantage is the ability of the sole proprietor to hire her spouse and provide the spouse with a healthcare reimbursement arrangement, which is tax-deductible.
- Entrepreneur: LLC Basics
- Internal Revenue Service: LLC Filing as a Corporation or Partnership
- Internal Revenue Service: Limited Liability Company
- Citizen Media Law Project: Limited Liability Company
- Business Know-How: The Big Hidden Tax Benefits of Sole Proprietorship
- PDXCPA: SingleMember Limited Liability Company
- IRS: Form 8823 and Instructions
A freelance writer since 1978 and attorney since 1981, Cindy Hill has won awards for articles on organic agriculture and wild foods, and has published widely in the areas of law, public policy, local foods and gardening. She holds a B.A. in political science from State University of New York and a Master of Environmental Law and a J.D. from Vermont Law School.