tax rules that apply to llc formation

An LLC formation creates an entity that can, for tax purposes, be almost anything you want it to be.

Rules for Single-member (owner) Limited Liability Companies

For example, an LLC with one owner can be disregarded for income tax purposes, and the LLC's activities are simply reported on the owner's regular income tax return.

In the case of an LLC owned by a single person operating an active trade or business, this "disregarded entity" approach means the LLC is treated as a sole proprietorship.

In the case of an LLC owned by a single person who passively invests in things like real estate or securities, this "disregarded entity" approach means that the investment income and deductions are reported on the person's regular tax return using Schedule D or Schedule E as appropriate.

A one owner, or single member, limited liability company can also be treated as a C corporation or even as an S corporation. To have an LLC treated as a C corporation, the LLC files a form 8832 with the Internal Revenue Service. To have an LLC treated as an S corporation, the LLC files a form 2553 with the Internal Revenue Service.

By the way, an LLC owned by a husband and wife who reside in a community-property state can be treated as a single-member, or one owner, LLC, meaning that such an LLC can also opt for "disregarded entity"-type reporting.

And a final point about single-member LLCs. A single-member LLC owned by a corporation is disregarded as an entity, too, which means that the LLC's income and expenses are reported on the parent corporation's return with the parent corporation's other income and deduction items.

Rules for Multiple-member (owner) Limited Liability Companies

An LLC with multiple owners can be treated as partnership--and partnership treatment is the default classification. Alternatively, the multiple owner LLC can elect to be treated as a C corporation or an S corporation.

Other Resources About Taxation of Limited Liability Companies

Much of the information provided in the Do-It-Yourself LLC Formation Kits sold at this web site talk about deciding whether you should make the election to convert your LLC into a C corporation or an S corporation. Converting an LLC to a C corporation can sometimes save small businesses thousands or tens of thousands of dollars a year in state income taxes. Alternatively, converting an LLC to an S corporation can sometimes save businesses thousands of dollars a year in payroll taxes for each LLC member.

Also, note that the Internet provides additional information about both the federal tax and state tax laws that relate to S corporations including LLCs that elect to be treated as S corporations.