Is a Single-Member LLC Taxed as a Corporation?

A Single-Member LLC (SMLLC) is not automatically treated as a corporation for tax purposes. As a rule, the IRS classifies a single-member limited liability company as a disregarded entity for federal tax purposes.

This means that the profit or loss of the business activities of a member-managed LLC taxed as a pass-through entity would be recorded in the member’s tax returns as opposed to separate taxes applying to the LLC.

However, a single-member LLC can change the election from the default position. If the business objectives or the tax planning prospects are necessitated, an LLC with a single member can elect tax as a corporation.

In this article, we will learn how those tax treatment options work by looking at all three: the default treatment, the election alternatives for SMLLCs, and the consequent tax consequences.

Default Tax Treatment of a Single-Member LLC (Disregarded Entity)

For the tax regulations, a single-member LLC is classified under the disregarded entity regulation. Under this arrangement:

Income Tax Reporting: The income, expenses, and deductions associated with the activities of the LLC will all be reported on the owner’s individual income tax. Usually, Schedule C which covers Income or Loss From the Business is used within Form 1040 for reporting such transactions.

• If income is realized by the LLC and derives from rentals, such income and expenses will be for Schedule E – Supplemental Income and Loss.
• Farming income would be reported on Schedule F under the Profit or Loss From Farming segment.

Taxable Income: The business profits of the LLC are taxed under the respective federal income tax bracket of the owner of the LLC. Moreover, the self-employment taxes (Social Security tax and Medicare taxes) are also applicable to the net income.

Tax Simplicity: As there is no filing of a separate federal income tax return for the LLC, it is a relief for the owner from the burden of more administrative work and making tax filings in a detailed manner.

For nearly all single-member LLCs this default classification is satisfactory due to its default simplicity. However, this default setting might not be optimal in terms of taxes as the businesses mature and the surplus economically expands.

Electing Corporate Taxation for a Single-Member LLC

The single-member LLC also can choose the classification as a C corporation or S corporation by filing specific forms with the IRS. There can be benefits when corporate taxation is chosen such as having a lower self-employment tax, keeping some part of the earnings in the business, and more options in terms of reinvestment or growth.

1. C Corporation Taxation

How to Elect: The owner of the LLC must furnish to the IRS and complete Form 8832 (Entity Classification Election) to be taxed as a C corporation.

Tax Implications:

• Since the LLC is an independent taxable entity, it has to submit a separate tax return which is Form 1120, U.S. Corporation Income Tax Return.
• Profits of LLC are taxed at the corporate income tax level rate, which is currently 21% according to federal law, and this may be lower than the tax rate of the business owner.
• If the owner draws dividends from the corporation, these are subject to federal income tax once at the corporate level and once again on the owner’s income tax.

Advantages:

• This makes it easy to retain earnings in the business since only earnings paid out as dividends are taxed at the individual level.
• Assists in obtaining benefits that are on the corporate level like tax deductibles for fringe benefits such as health insurance and retirement plans.

Disadvantages:

• Overall tax efficiency might be lowered due to double taxation especially in the case when the LLC pays out most of its profits to the owner.
• More administrative burden bears higher taxes and compliance requirements.

2. S Corporation Taxation:

How to Elect: For the LLC owner to elect to be treated as an S Corporation, he or she must fill out Form 2553 (Election by a Small Business Corporation). Some conditions must be fulfilled for the LLC to be considered an S Corporation, such as the fact that only one shareholder (the single member LLC owner) must exist and that it must be domestic.

Tax Implications:

• As with a disregarded entity, an S corporation is owned by another entity that is capable of taxing it. Any income, deductions, and credits accruing to the LLC are reported in the tax return of the owner, thus avoiding income tax at the corporate level.
• There is a major one that should be noted: self-employment taxes can be reduced. S corporations only tax the reasonable compensation (or salary) of their owners, which is the amount they draw themselves in the form of wages for Social Security and Medicare. The rest, which are identified as earnings received through dividends, do not suffer taxation.

Advantages:

• Completely and significant tax avoidance on self-employment taxes.
• This sustains Pass-through taxation without any residuals of double taxation prevalent in C corporations.

Disadvantages:

• The IRS demands that the owner should pay him/herself a “reasonable salary”, which will automatically attract payroll taxes. In addition, in the case where the salary is low, the IRS has the power to regard low dividends received as salaries and thus, apply further tax charges or penalties.
• More forms are needed as part of the payroll duties which include paying payroll taxes as well as submitting Form 1120-S, the U.S. Income Tax Return for an S Corporation, and quarterly payroll tax forms.

Key Considerations for Choosing a Tax Classification

Single-member LLC owners contemplating whether to opt out of the default classification for tax purposes and switch to a corporate one must consider:

1. Level of Business Income:

For lower revenue-earning entities, the most simple and tax-friendly option is the overriding disregarded entities classification.

However, for relatively larger businesses, the S corporation taxation option helps to reduce the self-employment taxes while with the C corporation taxation option, the company can reinvest a good portion of the earnings.

2. Potential Savings Opportunities:

S corporations are generally an attractive option to single-member LLCs because they enable members to minimize self-employment tax by allocating their income in the form of salary and distributions

Though C corporations are double taxed, such corporations are suitable for companies with plans to reinvest almost all profits and defer personal income.

3. Administrative Tasks:

There are no additional policies to follow apart from filing income tax returns for the owner as such, the default classification is the most simple.

Choosing an S or C corporation status means that the owner of the business will have to prepare different tax returns for the business, and handle any salary issuing payroll as well as other corporate tax.

4. Growth and Expansion Plans

When it comes to seeking outside finance for the LLCs to issue shares, it seems a C corporation structure will suit their needs.

There is a selfish S corporation default classification which works for the small business owners or those who run the business alone.

Summary of Tax Options for Single-Member LLCs

Final Thoughts

An LLC with one member does not get taxed by default as a corporation, but there is the option to opt for the corporate tax which presents good options for planning the tax.

Suppose it is not your economy Class or S corporation but you were incorporated. In that case, making a lot of a company depends on the scale and profitability of the business occasioned by set goals that you have for the future.

If your business is complicated and you’re unable to decide on one tax classification, get assistance from a tax professional or an accountant to see possible choices of classifications and compliance with IRS requirements.