Frequently Asked Questions Related to LLCs

Limited Liability Companies are a relatively new concept in business structures and taxpayers have many questions regarding how becoming an LLC affects their tax return. Since the federal government does not recognize an LLC as a classification for federal tax purposes, such entities must figure out how they should file their federal returns. Here are three of the most common questions about LLCs.

What business return should an LLC use for federal tax purposes?

For Federal tax purposes, an LLC business entity must file as either a corporation, partnership or sole proprietorship tax return.

Federal tax laws will automatically classify and tax certain LLC business entities as corporations.

These entities are:

A business entity formed under a Federal or State statute or under a statute of a federally recognized Indian tribe if the statute describes or refers to the entity as incorporated or as a corporation, body corporate, or body politic.

An Association under Regulations section 301.7701-3.

A business entity formed under a Federal or State statute if the statute describes or refers to the entity as a joint stock association.

A state chartered business entity conducting banking activities if any of its deposits are insured by the FDIC.

A business entity wholly owned by a state of political subdivision thereof, or a business entity wholly owned by a foreign government or other entity described in Regulations section 1.892.2-T.

A business entity taxable as a corporation under a provision of the code other than section 7701.(a)(3).

Certain foreign entities (see Form 8832 instructions).

An Insurance Company.

How Does A Business Elect an Entity Classification?

An LLC that is not automatically classified as a corporation can file Form 8832 to elect their business entity classification. A business with at least 2 members can choose to be classified as an association taxable as a corporation or a partnership, and a business entity with a single member can choose to be classified as either an association taxable as a corporation or disregarded as an entity separate from its owner, a “disregarded entity.” The Form 8832 is also filed to change the LLC’s classification.

What is the effect of Not Electing and Entity Classification, the Default Rules?

If an LLC does not File Form 8832, it will be classified, for Federal tax purposes under the default rules. The default rules provide that if the LLC has at least two members and is not required to be classified as a corporation, it will automatically default as a partnership, and be required to file a partnership return. An LLC that has only a single member and is not required to be classified as a corporation will automatically default to the classification of disregarded entity. The disregarded entity files as a sole proprietorship and completes the appropriate schedules as part of the single owners Form 1040.

What is the Effective Date of My Election?

The election to be taxed as the new entity will be in effect on the date the LLC enters on line 8 of Form 8832. However, if the LLC does not enter a date, the election will be in effect as of the form’s filing date. The election can not take place more than 75 days prior to the date that the LLC files Form 8832 and the LLC cannot make the election effective for a date that is more than 12 months after it files Form 8832.

However, if the election is the “initial classification election,” and not a request to change the entity classification, there is relief available for a late election (more than 75 days before the filing of the Form 8832). See the instructions for Form 8832.

What form should the LLC file, and how does income get from the LLC to the Form 1040, U.S. Individual Income Tax Return?

The business structure of the LLC and/or the election the business made dictates which federal tax form the business must file.

If the LLC is a sole proprietor for federal tax purposes, the entity should file either:

Form 1040 Schedule C, Profit or Loss from Business (Sole Proprietorship)
Form 1040 Schedule E, Supplemental Income or Loss
Form 1040 Schedule F, Profit or Loss from Farming
Form 1040 Schedule J, Income Averaging for Farmers and Fisherman

If the business has net income over $400, it may be required to file Schedule SE, Self-Employment Tax.

If the LLC is a partnership, it should file a Form 1065, U.S. Return of Partnership Income. Each owner should show their pro-rata share of partnership income (reduced by any tax the partnership paid on the income), credits and deductions on Schedule K-1 (1065), Partner’s Share of Income, Deductions, Credits, etc.

Finally, if the LLC is a corporation, it should file a Form 1120, U.S. Corporation Income Tax Return. The 1120 is the corporate income tax return, and there are no flow-through items to a 1040 from a corporate return. However, if the LLC filed as an S Corporation, it should file a Form 1120S, U.S. Income Tax Return for an S Corporation and each owner reports their pro-rata share of corporate income, credits and deductions on Schedule K-1 (Form 1120), Shareholder’s Share of Income, Deductions, Credits, etc.