Your LLC is a Unicorn

February 23, 2011 by  
Filed under Blog

New clients often ask me, “What kind of tax return do I file? I have an LLC.” To a tax person, this question has the unanswerable quality of a zen koan. For federal income tax purposes, your LLC is a mythical, non-existent creature, like unicorns or movie net profits.

Your tax status depends on how many people are in the LLC, and whether or not you have also incorporated. LLC stands for “limited liability company” ““ not corporation. If you want to be a corporation, you need to file Articles of Incorporation as well as filing for an LLC. These two things are often done at the same time, but they don’t have to be. (And if you do incorporate, for the love of Matlock get your Articles of Incorporation drawn up by a real lawyer who specializes in your type of business. Please don’t download some $50 form off of the Internet. Just don’t ; )

If you haven’t incorporated, and there’s only one member (or a married couple) in your LLC, it is treated as a sole proprietorship, and you will file your business taxes using Schedule C on your individual 1040 tax return.

If there is more than one member of your LLC, it will be treated as a general partnership, and you will need a 1065 partnership return. This comes as a great surprise to many people, who had the impression they could go into business together and each stay a sole proprietor. That’s not how it works. Like common-law marriage, you can become a partnership just by going into business with someone, no paperwork required. And like common-law marriage, somebody could end up losing a trailer ; ). It is well worth the lawyer’s fee to get a partnership agreement drawn up properly that does what you want it to do, rather than having to live with the default provisions in the law.

If you did incorporate, you may choose to be treated as a C corporation or an S corporation. A C corporation is what most people think of when they think “corporation”, like Starbucks or Cheezburger, Inc. C corporations have what is called “double taxation”. The income of the corporation is taxed on a form 1120 corporate tax return, and the dividends the owners receive are also taxed on their individual 1040s.

A S corporation has what is called “pass-through” or single taxation. The income is not taxed on the corporate 1120S tax return, but “passes through” to be taxed on the owners’ individual 1040s. You can elect to be taxed as an S corporation rather than a C corporation by filing Form 2553 with the IRS, as long as your corporation meets the criteria.

An LLC can be any of these business types. So have patience if your honest question “What kind of tax return do I file? I have an LLC.” results in a lot of questions for you, instead of a quick simple answer.

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