I continuously work with clients on tax structures, and I often weigh the benefits of LLCs (as partnerships and disregarded entities) as compared to S Corporations and C Corporations.
While an S Corp is still the most popular entity structure for most operating businesses (aside from real estate investing activities), I am seeing increased interest in C Corps. One of the main reasons is that we are seeing higher personal tax rates, but C Corp tax rates have stayed the same and there is some discussion in Washington of actually lowering them.
So if you are interested in a C Corp, then welcome the LLC C Corp. What does this mean? Well it’s really quite simple…
You form an LLC under state law and are taxed as disregarded entities. The IRS merely looks to the members to decide how they should be taxed. In general, when there is more than one member, then you would be taxed as a partnership, and if there is only a single member, then it is taxed as a disregarded entity.
However, even though the IRS has default classification rules, many taxpayers don’t realize that an LLC can elect to be taxed as an S Corporation or as a C Corporation. To be taxed as an LLC S Corp, the member(s) needs to complete and file for 2553 and to be taxed as an LLC C Corp the member(s) need to file form 8832 (Entity Classification Election). These are elections filed at the IRS level and most states to do require an entity classification filing.
Alternatively, many clients file as a state corporation (an Inc. rather than an LLC). This structure starts as a C Corporation and then you would elect to be treated as an S Corporation by filing form 2553 (as previously discussed). This step is very critical because many taxpayers believe that if they establish a corporation under state law that it defaults to an S Corp and that simply is not the case.
Determining the proper entity selection can be a tough decision and should not be taken lightly. The LLC C Corp and the LLC S Corp can both make a lot of sense, but it depends on your situation. There are also legal concerns relating to what entity you will file under state law…a corporation or LLC. State law varies and you should make sure to discuss the situation with your attorney and tax advisor.
Form 8832 is used for an entity classification election under the Internal Revenue Code. It is routinely used for taxpayers who have recently formed an LLC and are electing to be taxed differently than the IRS default classification for LLCs. You can implement key tax strategies for each structure.
Default classification
LLCs are legally organized at the state level. But the IRS has no actual tax distinction for the LLC itself. It merely looks to the number of members to determine how it is taxed. If an LLC has only one member, then the IRS considers it a disregarded entity. Assuming the member is an individual taxpayer, the activity would be reflected on the individual’s personal tax return. If the LLC has more than one member (a multi-member LLC) then the IRS will consider it a partnership for tax purposes.
Realize that if you are following the IRS default classification as stated above, there is no need to complete form 8832. You would only complete form 8832 if you were electing to be treated differently than the default classification. I normally see form 8832 completed when LLCs choose to be taxed as C Corporations.
Ask the right questions…
Form 8832 should be completed when the LLC paperwork is filed at the state level. But before you file the form, make sure you are able to answer the following questions:
- What is the difference between an S Corp and a C Corp?
- Do I understand the IRS default classification of the LLC?
- Do I need a CPA to help fill out for 8832?
- Have I filed the form within the prescribed time limits?
- Do I understand the filing requirements of 1120 (C Corp), the 1120S (S Corp), and 1065 (partnership)?
Selecting the proper tax entity can be a tough decision, so make sure that you do it with the help of a tax professional. Form 8832 is not that challenging of a form to complete, but make sure that it is timely and accurately filed.
Form 8832 is used for an entity classification election under the Internal Revenue Code. It is routinely used for taxpayers who have recently formed an LLC and are electing to be taxed differently than the IRS default classification for LLCs.
Default classification