S-Corp or C-Corp - How Should You Handle Your LLC Tax Treatment?
One of the first and crucial decisions you must make when beginning a business is the structure you want to utilize for your business. Each type of business structure has unique pros and cons that must be carefully considered to ensure the structure meets the owner’s goals and needs.
However, an often-overlooked consideration when choosing a business structure is the tax implications for the owners. An LLC may elect how it wants to be taxed: as a sole proprietorship, partnership, S-Corp, or C-Corp. Depending on the situation, electing one income tax structure over another income tax structure for an LLC can provide important tax benefits for the company and the owner. Because tax law can be complicated, it's beneficial to discuss your concerns and needs with a Maryland business tax attorney before electing how your LLC should be treated for tax purposes.
How is an LLC Taxed?
Many entrepreneurs choose an LLC for their business structure because an LLC offers limited personal liability while allowing for an increased level of flexibility for management and operations versus a corporation. Generally, the IRS classifies businesses for tax purposes as sole proprietorships, partnerships, or corporations (S-Corps or C-Corps). The IRS has no specific tax classification for LLCs. Therefore, you must examine the number of LLC members to determine how the IRS will classify the business for tax purposes.
Unless the LLC timely and affirmatively elects to be taxed as a corporation, the LLC will be subject to normal partnership tax rules.
The IRS classifies a single-member LLC as a “disregarded entity” and automatically taxes single-member LLCsas sole proprietorships. The single-member LLC has no other option. The revenue and business expenses of the LLC pass through the company directly to the member. The member reports the income and expenses attaching a Schedule C to his or her personal Form 1040 income tax return. Profits are taxedat the member’s individual income tax rate. Because the member is consideredas a self-employed individual, the member pays self-employment taxes (Medicare and Social Security) on the profits.
By default, the IRS classifies multi-member LLCs as partnerships for tax purposes. Unless the LLC timely and affirmatively elects to be taxed as a corporation, the LLC will be subject to normal partnership tax rules. Under partnership rules, the LLC must file an informational return (Form 1065) to report the business income, deductions, and each owner’s pro-rata share of profits and losses (Schedule K-1). Members are responsible for payment of individual income taxes based on the “pass-through” income, including payment of self-employment taxes (Medicare and Social Security). The LLC itself is not subject to income tax.
Electing a Different Business Entity for Tax Purposes
An LLC can elect to be taxed as an S-Corp or C-Corp instead of a sole proprietorship or a partnership. Choosing an LLC as your business structure allows for a great deal of flexibility for tax planning because the IRS permits LLCs to elect to be taxed as corporations. LLC members may benefit from either an S-Corp or C-Corp election depending on factors specific to the business.
An LLC can elect to be taxed as an S-Corp or C-Corp instead of a sole proprietorship or a partnership.
For instance, being taxed as an S-Corp allows the member to be treated as an owner-employee. Therefore, instead of paying Medicare and Social Security as self-employed taxes, the owner-employee pays these taxes on the salary only with the LLC paying a portion of the self-employment taxes. Profits (paid as dividends) are not subject to self-employment taxes.
Another alternative is to be taxed as a C-Corp. While being taxed as a C-Corp adds a layer of income tax for the business entity that does not exist for other entity choices, this election may provide tax benefits in specific situations, especially when deferring the payment of income taxes is a priority.
It's difficult to decide whether being taxed as an S-Corp is best for your LLC. A Maryland business tax attorney can help you evaluate whether you will save money if you choose to be taxed as an S-Corp by weighing several factors including whether you expect to earn profits in excess of your salary. You must also weigh the added complexity of setting up tax withholding and filing additional tax returns against the potential benefits.
Ask a Trusted Maryland Business Tax Attorney for Assistance
Whether you have formed your LLC or you are forming a new LLC, contact Maryland tax attorney Steve Thienel. Maryland tax attorney Steve Thienel is dedicated to assisting clients in Maryland, Virginia, and throughout the DC Metro area and can provide trusted guidance and legal counsel regarding all tax issues you and your company will face.