A limited liability company business structure is popular among many small business owners because, similar to a C Corp, business activities and assets are generally separated from the owner’s personal property. Regular LLC’s however do not have the same taxation rules as C Corps. As a result, the owners of an LLC may experience unfavorable personal tax consequences. An LLC can remedy some of the tax consequences by electing to be treated as a C Corp with the Internal Revenue Service.
Default Classification for LLC's
An LLC is organized under state statute and is not formally recognized by the IRS for federal taxation purposes. If an LLC doesn’t make an election with the IRS to be treated as a C Corp or an S Corp, the IRS will tax the LLC under default classification. For federal purposes, an LLC with one member will be taxed as a sole proprietorship and an LLC with two or more members will be taxed as a partnership. Under these treatments, the owners will pay income and self employment tax on any LLC profits.
Electing C Corp Status
C Corps pay their own income tax and when an LLC makes an election to be treated as a C Corp, owners can eliminate the risk of accruing high self-employment tax bills. An LLC can file IRS Form 8832 to elect to have the business classified as a corporation. Each member of the LLC must agree to the election and sign the form before it can be submitted to the IRS.
When to Make Election
The best time for an LLC to make an election with the IRS to be treated as a C Corp is immediately after forming the LLC with the state. An existing LLC must wait until the beginning of a new tax year to make the election. The IRS does not allow an existing LLC to back-date elections beyond 75 days, so the election must be made by March 15.
Payments to owners differ greatly between disregarded LLC and C Corp structures. Payments to owners of regular LLC’s are made directly out of company profits, while C Corp owners must be paid as W-2 employees. If the LLC has no other employees, electing C Corp status will create additional payroll tax obligations.