How the IRS classifies an LLC by default

Published by Vermilion Vitez Holding LLC, which sells LLC formation and resells registered-agent service fulfilled by Registered Agents Inc.

The steps, in order

1. The defaults

   An LLC is a business structure created under state law, and the IRS decides how it is taxed at the federal level. A domestic LLC with at least two members is classified as a partnership unless it files Form 8832 and elects to be treated as a corporation. An LLC with a single member is a disregarded entity unless it files Form 8832 and elects corporation treatment.

   One limit applies to a disregarded single-member LLC: for employment tax and certain excise taxes, the IRS treats it as a separate entity even though it is disregarded for income tax.

2. How each default reports

   A disregarded single-member LLC reflects its activities on the owner's federal tax return. For an individual owner, that is generally Schedule C, Schedule E, or Schedule F. An owner who operates a trade or business pays self-employment tax on the net earnings in the same way a sole proprietor does.

   A partnership files Form 1065, and each owner reports a pro-rata share of income, credits, and deductions on Schedule K-1. A corporation files Form 1120, and a qualifying LLC that elected S corporation status files Form 1120-S with each owner reporting a share on Schedule K-1 (Form 1120-S).

3. Electing corporation treatment

   Form 8832 is the entity classification election. An eligible entity uses it to be treated as a corporation, a partnership, or an entity disregarded as separate from its owner. The form is also how an LLC changes its classification later.

   A classification election generally cannot take effect more than 75 days before the date the election is filed, and it cannot take effect later than 12 months after that date.

4. Publication 3402

   Publication 3402, Taxation of Limited Liability Companies, collects the federal income, employment, and excise tax information for LLCs.

5. Entities that are corporations no matter what

   Some entities are treated as corporations automatically and do not get to choose. The IRS list includes a business entity whose statute describes or refers to it as incorporated or as a corporation, a joint stock association, a state-chartered bank with FDIC-insured deposits, and an entity wholly owned by a state or a political subdivision. An LLC is not on that list.

6. A special rule for spouses

   A business owned solely by a husband and wife as community property can be treated as a disregarded entity or as a partnership, and the IRS accepts the position the owners take. A change in that reporting position is treated as a conversion of the entity.

7. The state side is separate

   The classification above is federal. Forming the LLC is a state filing, and Vermilion Vitez sells LLC formation at $123.75 plus the state filing fee.