I read your article about incorporating to limit taxes. How about forming Limited Liability Corporations (LLC’s)? When you form an LLC for real esate holdings to limit liability, do you file as an individual or do you have to file for the LLC?
This is one of those questions that feels like it should have an easy answer but it doesn’t… The answer is “it depends.”
Limited Liability Corporations, or LLCs, are hybrid entities. They are generally structured like a corporation which offers, as you mentioned, the ability to limit liability, but have a number of options for tax purposes:
- Disregarded Entity. If you elect for your LLC to be treated as a disregarded entity (for example, as a single member LLC, or SMLLC), you would not file a separate tax return for the LLC and would simply report income and expenses on your individual federal income tax return.
- Partnership. For years, the fallback option for many LLCs was to be taxed by a partnership; this is still a popular choice since partnership taxation is generally assumed if another election is not filed. If an LLC is treated as a partnership for tax purposes, the LLC will file a partnership tax return (form 1065) and pass along income and expenses using a schedule K-1 to the partners according to their ownership percentages or partnership agreement. The individual partners will then report their representative share of the income and expenses according to their respective schedule K-1.
- S Corporation. More and more LLCs are electing to be taxed as an S Corporation; S treatment must be elected for an LLC, it is not automatic. S Corporations have pass through tax treatment similar to those of a partnership but with some key differences. If taxed as an S Corporation, the LLC will file an S Corporation tax return (form 1120S) and pass along most income and expenses (with certain exceptions) to the shareholders according to their ownership percentage or Shareholder’s Agreement. The individual shareholders will then report their representative share of the income and expenses according to their respective schedule K-1.
- C Corporation. An LLC may also be taxed like a C Corporation (the “traditional” corporate form). Although many tax pros shudder at the idea of electing C treatment, there are some instances where it might make the best sense (when, for example, there are foreign withholding issues or if there are multiple tiers of taxation). If taxed as a C Corporation, the LLC will file a C Corporation tax return (form 1120). Income and expenses are not passed along to shareholders; however, to the extent that dividends or other taxable income is paid out to the shareholders, that income is reportable by the shareholders on an individual tax return.
This brief explanation isn’t meant to make anyone an expert on LLC taxation. It can be tricky, depending on your circumstances. The point is that there is not a “one size fits all” answer and that your method of taxation depends on your elections.
It’s also important to note that there is no such thing as a federal version of an LLC: LLCs are governed by state law and some states have very distinct LLC treatment, including specific tax and other elections/requirements. LLCs are organized at the state level and tax treatment may be elected at the federal level. Even if an entity is treated one way for federal purposes, it may be treated differently for the purposes of state or local taxes. I highly recommend seeking legal representation to help you determine which options are best for your needs. Remember that many elections are time sensitive so take this into consideration when seeking advice.
Like any good lawyer, I need to add a disclaimer: unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.