LLC Pass Through Taxation

By Brian Richards

Corporate entities are frequently subject to double taxation, which means that money earned is taxed at two different times. LLCs are often attractive business structures for small business owners because LLCs may elect a pass through taxation. Though the cornerstone of an LLC is its limited personal liability for the managers or members, the availability of pass through taxation is one of the LLC's biggest advantages.

Double Taxation

C-Corporations are subject to what is called double taxation. When the corporation earns a profit, it must pay corporate taxes on the funds. These funds become corporate assets that are unavailable to the corporation's owners. For the owners to gain access to these funds, they must may themselves a dividend. The IRS then taxes this dividend at the individual's personal income tax rate. Thus, the money a corporation earns is taxed twice before it goes into the owners' pockets.

Pass Through Taxation

Partnerships and sole proprietorships are considered pass through tax entities, meaning the money these companies earn is taxed only once. Each owner reports his share of the profits on his personal tax return, and the money is taxed only at the individual owner's personal income tax rate. LLCs may elect to be taxed like a partnership or sole proprietorship and gain the benefits of pass through taxation.

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Election

When the members of an LLC form their company, they must file a document called the articles of organization with their state's Secretary of State. Each state has its own form to fill out, which will include a box the owners may check if they elect their LLC to be taxed as a pass through entity. The box may not use the words "pass through," and may instead have language indicating that the LLC will be taxed like a partnership. If the state form does not include such a box, the owners may include a statement that they choose to be taxed as a pass through entity.

Tax Return

Although LLCs do not have to pay tax at the corporate level, the LLC must still file a tax return with the IRS. The owners should submit Form 1065, which supplies information about the company's income and deductions. This return is purely informational, and no tax is due when it is submitted.

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Tax Consequences of Converting a C-Corp to an S-Corp

References

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