Federal tax law does not provide specific rules that govern every limited liability company. Instead, the Internal Revenue Service allows members of a LLC to choose between corporate, partnership and individual taxation. The type of tax return in which you report the LLC’s income and expenses depends on the tax structure you choose to apply.
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Limited liability companies that choose a corporate designation for federal tax purposes must file an annual corporate income tax return on IRS Form 1120. The IRS treats corporate entities as a separate taxpayer from the members and shareholders who own an interest in the business. A corporate officer must maintain books and records for all business transactions and report taxable income and deductions on the corporate return. Any resulting tax liability is the sole responsibility of the corporation. Shareholders and members are not directly responsible for the corporation’s taxes. However, if the business fails to file a tax return or does not pay the taxes due, all corporate assets are vulnerable to IRS collection procedures.
If you designate the LLC as a partnership, the IRS requires you to file an annual Form 1065. The 1065 reports the partnership’s income and expenses for the year. However, the purpose of this form is to provide the IRS with an aggregate view of the business’ operations and is for informational purposes only. The partnership must also file a Schedule K-1 for each member or partner, along with the 1065. The K-1 assigns a portion of the income and expenses that the partnership reports on the 1065 to the partners based on their respective shares of ownership. Each LLC member must combine these amounts with income and deductions from other sources on a personal income tax return. The members are solely responsible for paying the federal taxes on the partnership’s income.
A single member of an LLC that the IRS designates as a disregarded entity does not have to file a business return. The member includes all of the LLC’s income and expenses on his Schedule C attachment to IRS Form 1040. Amounts reported on the schedule cannot include income from other sources or other LLCs. The net gain or loss listed on Schedule C is reported as “other income” on the first page of the 1040. The individual member is solely responsible for making all tax payments.
The members of a LLC can collectively decide to elect an entity designation that differs from the designation the IRS assigns. A valid election is made by preparing Form 8832 and attaching it to the tax return in the year the change is effective. Once the election is made, it remains in effect for 60 months before you can make a new election. A valid Form 8832 is effective for changing a corporation to a partnership or disregarded entity, a partnership to a corporation, or a disregarded entity to a corporation.