Dear Tax Talk:
If you are a single member of a limited liability
company, can the IRS, under current federal tax
law, tax this entity as an association taxable
at corporate income tax rates? The logic behind
such an argument is that a partnership, by legal
definition, requires two or more persons or entities
carrying on a common trade or business for profit.
The IRS used to get into many disputes with taxpayers on how their entity should be classified for tax purposes. It clogged the court systems, gave taxpayers uncertainty and made attorneys rich. Several years ago, Congress acted to clarify entity selection by using a check-the-box approach. Under entity selection, certain recognized entities are automatically given a default classification. A recognized entity or certain nonrecognized entities, such as those from foreign countries,
can choose to be taxed as a different type of entity by completing the check-the-box Form 8832.
A limited liability company, or LLC, is an entity formed under state law by filing articles of organization as an LLC. None of the members of an LLC are personally liable for its debts. An LLC may be classified for federal income tax purposes as a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in regulations section 301.7701-3.
By default, an LLC with more than
one member is considered a partnership for tax
purposes. A partnership is the relationship existing
between two or more persons who join to carry
on a trade or business. Each person contributes
money, property, labor or skills, and expects
to share in the profits and losses of the business.
A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its partners. Each partner includes his or her share of the partnership's items on his or her tax return.
An LLC with only one member is disregarded for tax purposes as an entity apart from its member. If the member is an individual, then the LLC is taxed either as sole proprietor, Schedule C in the case of an operating business, Schedule E in the case of rental property or Schedule F in the case of a farm. If the member is a corporation, the income and deductions of the LLC become those of the corporation.
An LLC can apply to be taxed as a corporation (i.e., an association)
whether it has one member or more. It can also
make an S-Election, if it is otherwise eligible
to make that election. Form
8832 provides additional information on entity