LLC Classification Differences on a W9

When you do business with vendors or independent contractors, use IRS form W-9 to obtain certain tax information from them. If they operate their business as an LLC, their W-9 can indicate one of several tax classifications -- sole proprietorship, partnership or corporation. In most cases, LLC owners can elect their own tax classification with IRS approval. The tax classification indicated on the W-9 should be the same classification approved by the IRS.

An LLC is created under state law and is generally considered a hybrid legal entity that combines aspects of a corporation and partnership. LLC owners are referred to as members, and an LLC can be created with just one member or an unlimited number of members. Federal income tax law does not include a tax classification for LLCs. For income tax purposes, the IRS treats an LLC as a disregarded entity and assigns one of two default tax classifications to it depending on the number of its members. Sole proprietorship is the default classification for an LLC with only one member; a multi-member LLC is classified as a partnership. Under these classifications, the LLC's profits and losses are reported on its members’ individual tax returns.

IRS rules give LLC members the option of choosing a corporate tax classification rather than accepting the default tax classifications. Depending on the type of business operated by the LLC, the corporate tax classification may be more advantageous for LLC members because LLCs are eligible for special business tax deductions. To elect corporate tax classification, the LLC must file Form 8832, the Entity Classification Election, with the IRS. In approximately 60 days after filing the form, the LLC will be notified by letter of the acceptance or rejection of the corporate tax election by letter, regardless of the outcome.

The default federal tax rules for a corporation are set forth in Subchapter C of the Internal Revenue Code. These rules require, among other things, that the profits of a corporation be taxed at the corporate level before being distributed to the corporation's owners, after which they are taxed again. This presents a double taxation problem for most small business taxed as a corporation. To avoid this problem, a corporation can elect to be taxed under Subchapter S of the Internal Revenue Code by filing form 2553, called Election by a Small Business Corporation, with the IRS. Once this is approved, the corporation's profits and losses will flow through to the owners -- like a partnership -- and not be taxed at the corporate level. An LLC that elected a corporate tax classification can also elect to be taxed as an S corporation.

When you provide your vendors and independent contracts with Form W-9, IRS rules require them to complete the form and return it to you. In addition to indicating a business tax classification, a completed Form W-9 should also include the business's taxpayer identification number, legal business name and address. The form requires the business to certify whether it is subject to backup withholding which, if applicable, will require you to withhold a portion of your payments to the business and transmit the withheld amount to the IRS. The completed form is kept with your business records and not filed with the IRS. You can use the information on the form to prepare any 1099s you are required to provide the IRS.