Tax Differences of LLCs & PCs

by David Carnes
LLCs are exempt from entity taxation at the federal level.

LLCs are exempt from entity taxation at the federal level.

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A limited liability company is a company, typically with a small number of owners, known as members, that enjoys the same limited liability benefits as a corporation. All states now allow one-member LLCs; some states allow professionals to form professional limited liability companies, or PLLCs. A professional corporation, or PC is a special type of corporation designed for professionals such as lawyers and accountants. LLCs and PCs are taxed quite differently.

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Basic Taxation Scheme for LLCs

An LLC with at least two members is taxed as a partnership at the federal level unless it elects to be taxed as a corporation. This means that the LLC itself is not taxed, although it must file an informational federal income tax return. The IRS taxes individual LLC members in proportion to their ownership interests in the LLC. Members are taxed on all of the LLC's taxable income every year, regardless of whether the LLC actually distributes income to its members. If the LLC has only one member, he is taxed at individual income tax rates unless he elects to be taxed as a corporation. If the single-member LLC is an entity -- such as a corporation, trust or estate -- it is taxed at the rate applicable to that entity. LLC members must pay self-employment tax on their shares of the LLC's taxable income.

Basic Taxation Scheme of a PC

A PC is taxed in a manner similar to a "C" corporation unless it elects to be taxed as an "S" corporation. Under C corporation taxation, the entity itself is taxed at corporate tax rates and must file a corporate income tax return. PC shareholders must be individuals and are taxed at individual income tax rates. Shareholders are taxed only when the corporation actually distributes income to them -- in the form of salary or dividends, for example. This double taxation is particularly burdensome because PCs are generally taxed at the highest corporate tax rate of 35 percent.

Special Features of PC Taxation Scheme

Although PCs are taxed almost identically to "C" corporations, PC shareholders do enjoy two tax advantages that are unavailable to ordinary corporate shareholders. Shareholder-employees are eligible for group, term life insurance of up to $50,000 per employee. The corporation may deduct the cost of these premiums from its taxable income; the shareholder-employee is not taxed on these amounts. In addition, shareholder-employees are eligible for health and accident insurance plans. The corporation may deduct the cost of premiums; the shareholder-employees are not taxed on these amounts.

The Corporate Taxation Election

An LLC may elect to be taxed as a C corporation; both LLCs and PCs may elect to be taxed as S corporations by filing the appropriate forms with the IRS. In an S corporation, like an LLC, all business profits "pass through" to the owners. Forming an S corporation generally allows the owner/owners to pass business losses through to their personal income tax returns, where they can use it to offset any income that they and their spouses, have from other sources. S corporation owners/shareholders are not subject to self-employment taxes as active LLC members are. PCs that elect to be taxed as S corporations are exempt from the higher tax rates applicable to personal service income. The S corporation does not pay income tax, but an S corporation with more than one owner must file an informational tax return.