Choose Your Own Tax Status with an LLC
As the owner of a limited liability company (LLC), you have the unique ability to choose how you want to pay taxes on your business. LLCs can be taxed as partnerships (with pass-through taxation) or as sole proprietorships (if the LLC has only one member); or they can even choose to be taxed as a corporation or an S corporation.
Although you can’t easily flip back and forth from one type of taxation to another, this sort of flexibility is unique to LLCs. For example, corporations can’t choose to be taxed like partnerships, and general partnerships can’t choose to be taxed like corporations. LLCs have a choice, and in the business world, flexibility can determine success or failure.
Making your tax status selection
The default tax status for LLCs with more than one member is partnership tax status. If you want to elect any other form, you must file a Form 8832: Entity Classification Election with the IRS. You can download a copy of the IRS form (including instructions).
When filing Form 8832, you can elect the new form of taxation retroactively up to 75 days. Under certain circumstances, the IRS may even allow you to elect a different form of taxation retroactively up to three years and 75 days, however it’s best to make your election on time.
After you file Form 8832 and elect a different form of taxation for your LLC, you are stuck with that chosen method of taxation for five years (called the 60-month rule).
Single-member LLCs and the IRS
A single-member LLC (an LLC with only one member) is automatically considered by the IRS to be a disregarded entity and, by default, is taxed exactly as it would be if it were simply a sole proprietorship. This doesn’t affect the basic liability protection of the LLC, but it does change the tax rules.
A single-member LLC has fewer options when it comes to electing a form of taxation. Because it’s not technically a partnership, the IRS restricts it from electing partnership taxation. In this case, you have three options:
You can do nothing and be taxed as a disregarded entity.
You can elect to be taxed as a corporation by filing a Form 8832: Entity Classification Election with the IRS.
You can elect S corporation taxation by filing Form 2553: Election by a Small Business Corporation. Keep in mind that if you choose to be taxed as an S corporation, you’ll be subject to the same membership limitations as S corporations.
If you are a single-member LLC and want to be taxed as a partnership, you can always issue a small percentage of your company to a trusted friend or family member and avoid this situation entirely. Or, as an alternative to bringing friends or family on board, you have the option of forming a corporation — with you as the sole shareholder — and having the corporation be your partner in the LLC.
If you live in a state in which forming a corporation is a costly endeavor, you can always form your corporation in a less-expensive, tax-free state, such as Nevada. You pay about $125 per year in registration fees; however, your LLC gets the benefit of partnership taxation.
Nevada is a great state for forming a “partner” corporation because of the privacy it offers. You see, Nevada doesn’t require you to disclose who the shareholders of a corporation are. This privacy is beneficial if for some reason you don’t want anyone to know that the partner in your LLC is actually, well, you.
If you are a single-member LLC, you are not eligible to elect partnership taxation on Form 8832.