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Tax Considerations

Business Law

Tax Considerations

There are numerous tax consequences that need to be considered when operating a business. Depending on your business’ needs and long term goals, the type of tax entity you have chosen may have beneficial or undesirable tax consequences to you. The treasury regulations have default classification rules for tax treatment of limited liability companies. The default classification for a single member limited liability company (“LLC”) will be a disregarded entity and treated as a sole proprietorship for federal tax purposes. An LLC with two or more members will be treated as a partnership for federal tax purposes under the default rules. The federal regulations allow for certain types of entities to elect how they will be treated for federal tax purposes. The entities do not have to make an election, since the regulations will assign these default classifications. However, an election is necessary if the entity wants a different classification than the one provided in the default rules. The federal regulations allow a single member LLC and a multiple member LLC to elect to be taxed as a corporation.

However, a single member LLC may not elect to be treated as a partnership. Additionally, the procedure for an LLC electing to be taxed as a corporation is by filing a Form 8832 or Form 2553. The Form 8832 is the entity election classification form for federal tax filing purposes. If the LLC also wants to be taxed as a subchapter S corporation then it could alternatively file the Form 2553. The IRS recognizes this form as both the election to be treated as a corporation and for the S corporation election. The Form 2553 has strict time limits and must be filed within two months and 15 days from the time the LLC wants to be taxed as an S corporation. Typically, LLCs would prefer to be either disregarded as an entity or treated as a partnership to allow the pass through of income. However, by electing to be taxed as an S corporation, the LLC still enjoys the benefits of the pass through treatment and avoids the double taxation of a C corporation. Although being treated as an S corporation imposes limitations on ownership by different types of shareholders and restrictions on different classes of stock.