The Limited Liability Company (LLC) is, for federal income tax purposes, a pass-through entity like a partnership or S corporation, but it includes the limited liability of a corporation.
LLCs are created by statute and vary from state-to-state. The operating agreement sets forth the relationship of its members (owners) and governs how the LLC will be operated, allocation of earnings, capital contributions and distributions. The formalities found in the corporate business organization, like directors meetings, written minutes, etc., may not be required.
Federal Income Taxation of LLCs
Federal income tax law5 provides some flexibility as to how an LLC and its members are taxed:
Single member LLC: An LLC with a single member by default is “Disregarded as an entity separate from its owner…”. For LLCs with a single individual member, this means that income and expenses are generally reported on the individual’s personal return on Schedule C, E, or F. An LLC with a single individual member may elect to report income and expenses as a corporation. For LLCs with a single corporate member, income and expenses are typically reported on the corporation’s return.
1 Limited partners cannot participate in management.
2 For a member-managed LLC. In a manager-managed LLC, members do not typically participate in management decisions.
3 The S corporation is currently limited to 100 shareholders and there can be only one class of stock.
4 C corporation’s net income is subject to the corporate federal income tax up to 35%.
5 See IRC Reg. 301.7701-3.
- Multiple member LLC: An LLC with two or more members (individual or corporate) by default reports income and expenses as a partnership. Such an LLC may elect to report income and expenses as a corporation.
State income tax law can vary and does not necessarily follow federal law.
Seek Professional Guidance
When considering an LLC, professional legal and tax guidance is strongly recommended.