When it comes to operating a small business, limited liability companies (LLCs) come with a little more flexibility for their owners. One major choice that LLC operators enjoy is to choose how they wish to have their companies treated by the IRS when it comes to taxes. In IRS terms, this is referred to as the entity classification election (or ECE). Since the tax bill that a business owner gets can be a little eye-popping, it is essential to weigh all tax options. Bert Seither, The Startup Expert™, explains how this election process works.
In most cases, the IRS can classify an LLC under a few unique tax structures. These include S corporation tax status, C corporation tax status, sole proprietorship tax status, and partnership tax status. Selecting the best tax structure for your business is based on a bevy of factors, including the number of business owners involved in an LLC. Businesses have to file Form 8832: Entity Classification Election to make this election. To get S corporation tax status, Form 2553 may also need to be filed with the IRS with Form 8832. You may be able to file it separately as well.
When an LLC is arranged as a C corporation, this kind of company would be taxed at the corporate level as a separate business entity. In terms of the S corporation tax designation, LLCs are not taxed like their C corp counterparts. The shareholders invested in them instead split up any business-related taxes and handle them on their personal returns. Taxes levied on LLCs structured as sole proprietorships and those arranged as partnerships are passed through to their owners’ personal tax obligations. While these designations may seem identical to the S corporation tax status, the S corp option for an LLC can come with additional tax savings opportunities.
Bert Seither, The Startup Expert™, points out that there are numerous reasons why it is vital to grasp how this ECE concept works if you already operate or plan to start an LLC. In basic terms, the ECE is a decision designed to indicate to the IRS how an LLC owner wants to have his or her small business taxed. This election obviously has a major effect on the tax responsibilities of the enterprise at-hand, which impacts how much money an owner must give Uncle Sam in federal income taxes. Take the time to carefully consider which structure option fits your individual needs.
There is an important deadline on the calendar very shortly regarding the entity classification election, according to Bert Seither, The Startup Expert™. If you don’t make this election within the 75-day period between January 1 and March 15, your LLC will default to a less desirable, non-corporation designation. This would be a sole proprietorship for small business owners operating individually or a partnership if there are two or more partners on the paperwork. For tax year 2014, your LLC would be treated by the IRS as one of these more informal structures, and you may face steeper tax rates and fewer deductions if you fail to make this election by March 15. Keep in mind that you’ll have the chance to make this decision for your small business early next year. But you may be on the hook for higher taxes until that point. Also, don’t forget that this election will last for 5 years after it is made.