How Do You Classify A Domestic LLC with the IRS?

Michael Lodge

by Michael Lodge

This question comes up a lot from clients forming a new business.  How can a LLC be classified for tax purposes with multi members or one single member.

Question: For IRS purposes, how do I classify a domestic limited liability company? Is it a sole proprietorship (disregarded entity), partnership, or a corporation?

Answer:

A domestic limited liability company (LLC) is an entity:

  • Formed under state law by filing articles of organization as an LLC.
  • Where none of the members of an LLC are personally liable for its debts.

For federal income tax purposes, an LLC may be classified and taxed as a sole proprietorship (single member), partnership (multi member), or a corporation (single or multi member).

Generally, if a domestic LLC has:

  • Only one owner, the IRS will by default treat it as if it were a sole proprietorship (disregarded entity) unless the owner makes an election to have it treated as a corporation. Special rules exist for residents of community property states, where the qualified joint venture rules may apply (as referenced in Publication 541, Partnerships).
  • Two or more owners, the IRS will by default treat it as a partnership unless the entity makes an election to have it treated as a corporation.

Either one of these entities may elect a classification as a standard corporation. Use Form 8832, Entity Classification Election, to make this election. If a taxpayer does not file Form 8832, the default classification will apply. Different classification rules may apply in certain situations for certain types of businesses, including: banks, insurance companies, and nonprofit organizations that are also organized as an LLC.

Note: If an LLC that is otherwise disregarded has employees, the law treats it as an entity separate from its owner for reporting and payment of employment taxes.

If you have questions on this topic send your question to:  tax@icontaxgroup.com