What to Classify Your New Entity for Tax Purposes - IRS form 8832 v IRS Form 2553 - John R. Dundon II, Enrolled Agent
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What to Classify Your New Entity for Tax Purposes – IRS form 8832 v IRS Form 2553

What to Classify Your New Entity for Tax Purposes – IRS form 8832 v IRS Form 2553

Understanding how to file LLC taxes, S Corporation taxes and taxes for other business entities can be one of the biggest headaches of starting your own business. Filing taxes for a business entity like an LLC can be especially confusing because of all the various options the IRS allows for Limited Liability Companies.  Keep in mind that a Limited Liability Company from an IRS perspective is not a recognized tax classification. Therefore, for tax purposes, you must select an IRS-recognized business tax classification.

In determining your IRS tax classification ask yourself questions like….

  • How you plan to handle income?
  • How many people (members) are involved?
  • Do the members draw a salary from the company, or simply share revenue?
  • If there is only one member of an LLC, does that member want to claim company income on their personal taxes, or file taxes for the company separately?

File a IRS Form 8832 to elect tax classification. Form 8832 notifies the IRS which business entity or tax status you plan to employ for filing tax returns for the LLC. A sole member can opt to either disregard LLC status for tax purposes thus claiming income on their personal return or opt to file taxes as a corporation. A multi-member LLC can opt to select S Corporation classification and pass income to each member on a pro rata basis, file taxes as a partnership or opt to file corporate taxes as a separate entity.

IRS Forms 1040, 1120 and 1065 are all options for filing LLC taxes. Which form you use is determined by the tax classification chosen on Form 8832. If you’re a sole member and opted to disregard LLC status for tax purposes, you would use a standard Form 1040 for personal income reporting on schedule ‘C’ profit or loss from a business. If you elected to file LLC taxes as any form of corporation (regardless of membership size), you would use Form 1120. S Corporations file tax returns using Form 1120S to report pro rata shares paid to LLC members.

Two-member LLCs file taxes as a partnership and use Form 1065. The IRS offers extensive information to aid in tax filing for individuals, as well as businesses. They even offer an entire section devoted to tax filing for a Limited Liability Company. Single member LLC default is a sole proprietor filing schedule C with the 1040.

Both Single Member LLC’s and Multi Member LLCs can elect to be treated as a corporation for federal tax purposes (some states do not follow the fed). Yet still remain an LLC as far as a state Secretary of State is concerned. Once the corporate election is made an LLC can elect to be treated as an S-Corporation if fewer than 100 members are involved.

In addition to the legal considerations there are a complex tax issues to consider when deciding whether to make a corporate election and the timing of the election. Some have been mentioned. Net income of the company, payroll taxes, payroll service, cost of administering the additional entity tax return. But there are others. Employee benefits, medical expenses and health insurance (s-corp and sole prop and partnership have limitations), ease of adding and removing members, tax implications of hiring your kids (FICA taxes)

Form 8832 is not required to be filed unless you want to elect to be taxed differently than the default entity type as mandated by IRS. A Single Member LLC is automatically taxed as a sole prop, multi-member LLCs are automatically partnerships. Furthermore, if you want to elect to be taxed as an S-corp, you can bypass the 8832 in most cases and make the s-corp election using only the IRS Form 2553.

If an LLC does not File IRS Form 8832, it will be classified, for Federal tax purposes under the default rules. The default rules provide that if the LLC has at least two members and is not required to be classified as a corporation, it will automatically default as a partnership, and be required to file a partnership return. An LLC that has only a single member and is not required to be classified as a corporation will automatically default to the classification of disregarded entity. The disregarded entity files as a sole proprietorship and completes the appropriate schedules as part of the single owners on IRS Form 1040