I'm an LLC

I'm an LLC

By far the most common answer is an LLC or Limited Liability Company.  Just off the cuff, I'd say that nine out of ten small businesses choose to operate as an LLC. Surprisingly, knowing that you're an LLC tells us almost nothing about how your business will be taxed.  Here's why...

LLC's are a creation of the states, not the federal government.  They came out of western states with large oil and gas industries in the late 1970's and early 1980's.  They allowed for passive investment in businesses under streamlined rules.  Over the next several decades, they expanded and evolved into the modern LLC, allowing for active management, but with the same limited liability as passive investors.  I'm summarizing this fairly complex topic quite a bit.  (Start here for a really deep dive.)  I'm mainly focusing on the their operation as a vehicle for small business taxation.

So, the IRS was either brilliant or lazy when LLC's emerged on the scene.  Congress was unable to act fast enough to deal with them by writing a new chapter of the Internal Revenue Code.  The solution was the hilariously named "Check the Box Regulations".  (You really can't make this stuff up.)  The solution was to make LLC's play by a set of rules that was already in place.  The end result of the these regulations is that an LLC can, with a few exceptions, be whatever it wants to be for tax purposes.  You actually check a box on a form to select your entity of choice.

Let's start unpacking this topic with the default entity selection.  An LLC with more than one owner is by default a partnership.  One with a single owner is a disregarded entity.  That doesn't mean that the entity doesn't exist, just that it is ignored for federal tax purposes.  In other words, we look past the LLC to the owner to see how to handle it.  If the single member LLC, SMLLC for short, is a business, then that individual owner is self employed for federal tax purposes.  If they are renting property inside the LLC, then they report that rental activity on their personal return.  Investment activities may or may not need to even be reported.

Any LLC may make an election to be taxed as a corporation regardless of the number of owners.  This first step gets you to a C corporation.  That same LLC could make a further election to be taxed as an S corporation.  Recent regulations have streamlined this process to the point that we can now make an S election and get the election to be taxed as a corporation as an assumed first step.

So, an LLC could be taxed as a disregarded entity, a partnership, a C corporation or an S corporation.  Again, I'm only discussing businesses.  I'm omitting not-for-profit organizations, coops, political organizations and a host of other entities.  The only restrictions really are that SMLLC's can't be partnerships and multi member LLC's can't be disregarded entities.  Once a selection is made, it is in force for the life of the entity.  Making an entity selection binds the LLC to all federal laws and regulations for the entity selected.  As most states accept the federal election, there's usually nothing to do at the state level.  There are options to revoke these elections as well.  That's a bit beyond the scope of this article.

Let's discuss which entity makes sense for your business or investment venture.  We can even layer LLC's to create a hierarchy or have a series of sibling LLC's.  Better still, let's get your attorney involved in that discussion.  An attorney and a CPA working together can design a structure that meets your legal and tax needs.