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Entity Classification Election for LLCs
In the world of business entity ownership, a limited liability company (or LLC for short) offers lots of options and flexibility to those who own such a company. A big choice LLC owners are able to make involves deciding how they want the IRS to treat their business entities from a tax standpoint. In IRS lingo, this important decision is known as the entity classification election, often abbreviated ECE. Due to the various tax rules and regulations put on small businesses by the IRS, it’s critical to weigh your ECE options and learn how the specific tax structure of an LLC can significantly impact its financial standing from an earnings perspective.
LLCs can be categorized under several different structures in terms of taxes. These structures include C corporation status, S corporation status, sole proprietorship status, and partnership status. Deciding among these tax structures is based on many unique factors, including the number of owners involved in one LLC. The ECE can be made when a business owner files Form 8832: Entity Classification Election with the IRS.
If you opt to have your LLC taxed using S corporation status, your business will not be taxed at the corporate level. Instead, all shareholders invested in the company split all business-related taxes on their personal returns. Unlike LLCs arranged as S corps, those that are structured as a C corp are taxed at the corporate level as a separate business entity. This means there is a separate business tax return to be filed with the IRS rather than having the company’s taxes pass through to its owners. As far as LLCs structured as sole proprietorships and partnerships are concerned, the taxes on them are passed directly through to their owners’ personal income tax returns. This is similar to the S corporation structure of an LLC.
If you currently run or plan to own an LLC, there are many reasons why you should have a basic understanding of the entity classification election. The ECE is intended to tell the IRS how LLC owners want to have their businesses taxed. This decision has a big effect on the tax standing of a company in the IRS’ eyes, which results in how much money the LLC’s owners are on the hook for in federal income tax payments. Since each tax structure comes with pros and cons, it’s essential to explore each option to find the best one for your individual situation.
If an LLC owner does not communicate to the IRS how he or she wants a business to be taxed, the IRS will likely treat it in a way that requires higher taxes on earned income, along with fewer deduction opportunities. The reason for this is that the IRS will assume that a single-member LLC should be taxed as a sole proprietorship. As such, multi-member LLCs with more than one owner should be treated tax-wise as if they are a partnership.
There is a timeframe on when the ECE must be made after officially opening the doors to an LLC. If you do not elect a tax structure within the 75 days of launching an LLC, your company’s tax structure will default to either sole proprietorship status or partnership status, depending on the size of it. Keep in mind, however, that you can make this election starting January 1 of each year up until March 15 if you fail to do so after registering your company with the state.
Overall, the entity classification election for an LLC is imperative to putting such a business entity on the right tax track – and for the best chance at future prosperity and sustainability for a company.