This is Part 2 of our four-part series of blog posts where we are sharing the basics of using Limited Liability Companies (LLCs) as part of your asset protection plan. If you missed Part 1 of the series that was posted last week, you can check it out here: Part 1 – Introduction to LLCs.
In today’s post we are discussing how an LLC is taxed. Next week in Part 3 – Using LLCs to Own Investment Real Estate, we will discuss using LLCs to own investment real estate. Lastly, we will wrap up this blog post series in Part 4 with a discussion about the downside to using Florida LLCs and a brief discussion of why it can be beneficial to use LLCs formed in other states as a part of your asset protection plan.
How is an LLC taxed?
From a federal and state tax law standpoint, an LLC can be taxed in one of the following ways:
A Single Member LLC (an LLC owned by only one person or entity) can be completely ignored and considered transparent for federal tax purposes.
A Single Member LLC does not necessarily need to apply for a tax identification number. The tax identification of the owner of the LLC may be a person’s Social Security Number or of another entity, which is acting as the sole Member of the LLC. Tax returns are not required to reflect that the LLC exists, although it is advisable that the LLC would file a separate tax return for state law/creditor protection purposes.
Besides charging orders and tax neutrality, discounts as to valuation offers yet another significant tax advantage to forming a Single Member LLC. Although an individual can own 100% of an LLC, if a third party, which may include a trusted relative, is named the Manager of the LLC, with the power to make decisions and to withdraw management fees without the joinder or consent of the 100% Member/Owner, then on the death of the Member/Owner a significant discount may apply to the value of the LLC, thereby reducing the potential estate tax liability.
2. Partnership Treatment
An LLC with more than one Member is automatically treated as a partnership for tax purposes, unless an election is made to the contrary. A multiple- member LLC formed in the United States or certain other countries will be presumed to be treated as a partnership for federal tax purposes, unless a special election is made by the Members as described below.
3. Corporate Treatment
An LLC may be treated as an S corporation or a C corporation for federal tax purposes, provided its Member(s) file a Form 8832 as described below.
NOTE – Creditor protection will be the same whether an LLC elects to be treated as an S corporation or not. There is a common misconception that S corporations do not offer the same type of “firewall” protection as regular corporations do, LLCs taxed as disregarded entities or as S corporations offer the same protection of shareholders as any other type of company.
4. Electing Status
Under the “check the box regulations,” the Members may select between partnership and corporate tax treatment. Absent an affirmative election, a Single Member LLC will be ignored for tax purposes. An LLC with two or more Members will be considered a partnership for federal tax purposes, unless a Form 8832 or a Form 2553 is filed with the Internal Revenue Service within the first 75 days of the LLC’s existence, affirmatively electing to have the LLC treated as a corporation for federal tax purposes.
If the LLC is to be treated as a regular corporation, a Form 8832 is used. If the corporation is electing to be treated as an S corporation, then a Form 2553 is to be used. In the past, the IRS required that S elections be made by first filing a Form 8832 and then filing a Form 2553, but this duplicative process was eliminated in 2004.
Check back next week for Part 3 in this four-part series about LLCs. If you are interested in using LLCs as part of your asset protection plan, give our office a call at (407) 273-1045. Our experi