Introduction 

Unlike some other business structures, with LLC incorporation, you can choose from 3 taxation systems. Factors,  such as the number of participants, size of business, financial plans, are usually taken into consideration to make a considered decision. Some tax systems are available by default, while others require certain forms and requirements to be filed.

Is the standard tax status suitable for you, or is it more advantageous to be taxed as a corporation? In this article, we will explore this question in a little more detail.

What is an LLC?

A Limited Liability Company is a legal entity formed to conduct business in its own name. It combines the aspects of sole proprietorships, corporations, and partnerships to provide the most favorable conditions for businesses.

LLC incorporation is popular because of a number of factors. First and foremost, of course, is the protection of limited liability, which partnerships and sole proprietorships do not have. As in the case of the establishment of a corporation, by choosing an LLC business structure, you will be able to conduct business without worrying about your property (your house, bills, car, etc). 

Also, many entrepreneurs are attracted by the possibility of cheap LLC formation and simple maintenance requirements, which distinguishes it from a corporation. In addition, to save time and effort, you can hire one of the affordable company formation services such as MyСompanyWorks or ZenBusiness.

Another reason for choosing an LLC is the flexibility that allows you to set up your work with maximum efficiency. This applies both to the internal structure, which can be easily adapted to the needs of the business, and such an important aspect as taxation.

What is the Default Tax Classification Assigned with LLC Formation?

Unless otherwise specified by the owners during LLC incorporation, the company is treated by the IRS as a “pass-through” taxing unit. Most LLCs adhere to this particular system, which effectively helps avoid double taxation. 

Depending on the number of participants, there are 2 classification options:

• Single-Member LLC. If an LLC company is owned by a single member, it is taxed as a sole proprietorship. Such a business is not legally separated from the owner and in terms of tax law is an unreported tax unit. After Business formation, the owner states the LLC’s income and expenses on his or her own tax return. This is the simplest and most common option among small businesses. Another important benefit of choosing default taxation is that it saves time. This way, you can get to work right away instead of having to learn the requirements and fill out another form to switch to corporate mode. Although some of the best LLC services offer help with this, changing your taxation method takes time. Along with its advantages, the unaccounted for tax status has its disadvantages. The most significant of these is that the owner has to pay tax on all LLC company income, even if part of it is kept in a corporate account.

• Multi-Member LLC. If a company has 2 or more owners, the general rule is that the IRS treats it as a partnership. The company does not file its own return. Each owner reports his or her portion of the income and expenses from the business on the personal tax return. As with Single-Member LLC, this LLC incorporation option helps avoid double taxation. The disadvantages of default taxation for Multi-Member LLCs include the fact that this route can be inconvenient for passive participants. The tax liability arises whether or not they received a share in the distribution. This is one of the main reasons why investors prefer to invest in corporations rather than LLCs.

Because of its simplicity and efficiency, the tax status automatically assigned upon business formation is a great choice for aspiring LLC owners. However, you may want to consider corporate tax status if you:

• Are planning to keep significant amounts of money in a business account;
• Are interested in attracting investors and passive co-owners.

How and at what Stage of LLC Formation Can I Choose the S-corporation Tax System?

LLC members have the right to change their tax system once in 5 years. To do this, you should fill out the IRS Form 8832. It can be filed within 75 days after the date of incorporation or within 75 days of the following tax year.

However, the S-corporation system is not available to every company. The law establishes a number of requirements, which include the following items:

• All LLC members have to be resident-individuals, charities, or certain types of trusts;
• No more than 100 owners are allowed, each of whom has to agree to be taxed as an S-corporation;
• Identical property rights of the owners.

The advantages that an LLC company gets when choosing S-corporation type of tax treatment include the following:

• “Pass-through” taxation;
• The active participants, who manage the company, are considered to be its employees. In this case, the company pays tax on wages. The remaining funds can be distributed to the participants as dividends, resulting in a reduction of the owners’ overall tax liability.

The IRS makes sure that wages for participants are “reasonable.” Attempting to set the amount too high or too low will result in unwanted additional scrutiny.

The S-corporation tax system is not suitable for everyone. However, you should consider it after the LLC formation because, in some cases, it may provide certain benefits. If necessary, a professional service, like LegalZoom, can help with the paperwork. Because of their unparalleled reputation, this is one of the best LLC services in the industry.

How and at What Stage of LLC Formation Can I Choose the C-corporation Tax System?

The last available option of the LLC tax system is C-corporation. Unlike the others, such companies pay taxes and file income and expense tax returns on their behalf. The remaining profits are distributed to the participants in the form of dividends and are also subject to income tax. Such a situation is commonly known as double taxation.

Why is the C-corporation status attractive for the LLC company? First of all, unlike an S-corporation, they can have any number of participants without any restrictions on which entities are entitled to hold a share in the share capital.

Also, the active members of the C-corporation, according to the law, are its employees. This gives them medical and other benefits. Typically, such owners receive salary and non-dependent benefits, which they report on their personal tax returns.

Despite the double taxation, this system can be beneficial if used correctly. For example, if you are planning to attract investors after business incorporation.

Conclusion

Each tax system is unique. Choosing the right option is one of the key issues in the process of LLC incorporation, which requires careful consideration. If you are still in doubt as to which tax status best suits your company, then consult an expert. An experienced accountant or a tax lawyer can help you fully consider the specifics of your LLC, as well as provide helpful advice on taxes and fees.