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Is Your LLC a Sole Proprietorship, a Partnership, a C Corporation or an S Corporation?

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Published: 30May2008
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The Limited Liability Company (LLC) is a terrific tax entity. The number one reason is its flexibility. Specifically, an LLC can be taxed as:

a sole proprietorship
a partnership
a C corporation
an S corporation

An LLC is not a tax entity, it is a legal entity. As such, an LLC can choose how it wants to be taxed.

Do you know how your LLC is taxed? If your LLC did not make an election, then it is taxed as the "default classification." The default classifications are:

If your LLC has one member (owner), then it is disregarded for tax purposes. This means that all the LLC activity is reported by the owner and the LLC files no separate federal tax return.

Important note: Some sates require disregarded LLCs to file a state tax return.

If your LLC has more than one member, then it is taxed as a partnership and files a partnership tax return.

*Special rule*
If you and your spouse are the only owners, then you can choose which of the two classifications you want to use.

If your LLC made an election, then your LLC is taxed as a C Corporation or an S Corporation.

Do you need to make an election for your LLC to be taxed as a C Corporation or an S Corporation?

This election is typically recommended for operating businesses that are profitable. This election is typically not recommended for LLCs that hold investments, such as stock or real estate. LLCs that hold investments are typically best left in their default classification.

When should your LLC make the election to be taxed as a C corporation or an S corporation?

Once you have determined your LLC needs to make the election, you then need to consider the rules of when the election can be made:

General rule: The election can take effect up to 75 days prior to the date the election is filed and up to 12 months after the election is filed.

Example: An LLC files its election to be taxed as a corporation on October 15th. The effective date for the tax election can be as early as August 2nd (75 days prior to October 15th) or as late as October 15th of the following year or any date in between.

*Special rule*
For newly formed LLCs, in most cases, the LLC can file the election as late as the original due date of the first corporate tax return and the election is effective as of the first day of the LLC.

Example: An LLC is formed on May 1, 2008. The LLC files its election to be taxed as a corporation by March 15, 2009 which is the due date of the first corporate tax return. The effective date of the election can be as early as May 1, 2008.

Understanding the fundamentals of entities, particularly LLCs, is a key part of building a wildly successful tax strategy.

Tom Wheelwright is not only the founder and CEO of Provision, but he is the creative force behind Provision Wealth Strategists. In addition to his management responsibilities, Tom likes to coach clients on wealth, business, and tax strategies. Along with his frequent seminars on these strategies, Tom is an adjunct professor in the Masters of Tax program at Arizona State University. For more information please visit http://www.provisionwealth.com

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