Tax
Aspects of Limited Liability Companies
The limited liability company (LLC) is a hybrid of a
corporation and a limited partnership that is created under
state law. For federal tax purposes, an LLC is treated
identically to a partnership and it must file a Form 1065, U.S.
Partnership Return of Income. (There is an exception to this
rule for single-owner LLCs, which are treated identically to sole
proprietorships and whose owners must simply file a Schedule
C with their Form 1040.)
Under state laws, LLC owners are given the protection from
liability that was previously afforded only to corporate
stockholders. Although the LLC is a relatively new business
form, all of the states have now enacted legislation providing
for limited liability companies.
Formerly, the IRS had treated limited liability companies as
partnerships rather than as corporations only if the business
did not possess more than two of four characteristics of
corporations: centralized management, continuity of life, free
transferability of interests, and limited liability. Under
regulations that went into effect at the start of 1997, newly
formed LLCs can obtain partnership tax treatment even if they
have all four corporate characteristics; in fact an LLC will be
presumed to have partnership treatment unless it elects to be
treated as a corporation.
However, while LLCs are treated as partnerships for federal
tax purposes, the same is not always true for state tax
purposes. You'll need to check your state
tax laws.
Comparison with S corporations. While S
corporations also provide limited liability for their owners
and favorable pass-through tax treatment, LLCs do provide some
additional advantages to growing businesses. Like a partnership,
an LLC has the ability to make disproportionate distributions to
its owners (for example, a LLC member may have a 50 percent
ownership interest in LLC assets but be entitled to 60 percent
of the income, if the operating agreement so provides). In
contrast, S corporations must generally make all distributions
pro-rata in accordance with the number of shares held by each
owner. An LLC can have an unlimited number of investors, whereas
an S corporation is limited to 75 shareholders.
Other factors to consider. There are a number of nontax
factors that may influence your decision as to whether a LLC
is the right form of business for you, and we recommend that you
seek legal advice in setting up a LLC and writing up the
operating agreement.
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