Limited liability companies (LLCs) are state-created entities that under IRS code can elect to be treated in one of three distinct ways for the purpose of reporting and paying taxes. Understanding the various options and the reporting requirements for each helps determine the proper filing of documents such as K-1s.
Single Member LLCs
If an LLC has a single member, it is classified as a disregarded entity and is viewed as separate from its owner for income tax purposes. All the business activity, including gains and losses, are reported on the individual member's tax return using a variety of different schedules that accompany Form 1040. In this instance, there is no need for a Schedule K-1. However, the owner would use Schedule C, C-EZ, E or F, depending on the type of business.
Corporations and Partnerships
When an LLC has more than one member, the IRS automatically treats it as a partnership for tax purposes. In this instance, the LLC must issue K-1s to all the members, reporting all income, credits and deductions, based on the member's share of ownership. Schedule K-1 is also known as Form 1065, U.S. Return of Partnership Income. Members must include this schedule with their personal tax returns when they file.
An LLC with more than one member may choose to change its classification to that of either a C corporation or an S corporation using Form 8832. In both of these instances, Schedule K-1s must be issued to each shareholder of the corporation. Again, all income, credits and deductions must be reported, but only the amount equivalent to the percentage of each shareholder's ownership in the corporation. The C corporations use Form 1120, U.S. Corporation Income Tax Return, and S corporations must use Form 1120S, U.S. Income Tax Return for an S Corporation. Shareholders include their copy of the K-1 with their personal tax return when filing.
If an LLC wants to change the official classification by which it is viewed and taxed by the IRS, it can elect to do so. However, once this change is made, the new classification must remain for 60 months. Since tax filing requirements may change with a new election, including the necessity of filing a K-1, businesses should be sure that they understand the new requirements and file the appropriate forms. Additionally, if the structure of the entity changes by adding or losing a member, the classification may also change, and tax rules may be affected.
Elisabeth Natter has been writing news and information articles for over 15 years. She has done public relations work for several nonprofit organizations and currently writes content for business clients of her suburban Philadelphia communications company. She holds a Bachelor of Arts degree in journalism from Temple University.