Corporation Tax

Treatment of an LLC

A Limited Liability Company (LLC) is an entity that is created under a state statute, and depending on the elections made by it, the Internal Revenue System (IRS) treats it either as a corporation, or a partnership or a sole proprietorship. The LLC that has at least two members is considered the partnership for federal income purposes. More so, if it has only one member, it is regarded as an entity that is separate from its owner when income tax is under consideration. The IRS, however, will classify it as a different from its owner unit for purposes of employment taxand some excise taxes. The considerations mentioned above happen unless the LLC files for a form 8832 and is exclusively elected as a corporation. The LLC is disqualified from being the corporation under the entity classifications rules provided for business institutions. Under this regulation, a domestic entity that has more than one member is considered the partnership by default. However, form 8832 can be used to change the LLC’s business entity classification, which means that even if it has been the partnership for some years, it can still apply to be the corporation.

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Advantages of a LLC over a C Corporation

A LLC and a corporation are similar because they offer liability protection for their owners. However, there are several advantages in forming the LLC over the C corporation:

  • LLCs provide superior limited liability protection to its owners than that for corporations because it is harder to break through the veil and attach personal property to the LLC.
  • LLCs are also under single taxation where profit or losses are directly passed to the members. A corporation is double taxed where its income is taxed, and shareholders also pay it on their dividends or on the profits they receive.
  • Paperwork is limited in case of the LLC unlike that for the C corporation as they are required to report to shareholders who are the owners of the entity.
  • The LLC has the choice of taxation structure, in which it can be considered a single member, or partnership for multiple members or S or C corporation through the election. The choice of taxation for a C corporation, on the other hand, is fixed as they are taxed at the corporate tax rate.

Tax Consequences of Converting a C Corporation to a LLC

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In converting a C corporation to the LLC, several important tax considerations have to be made, taking into account the kind of business entity the LLC takes. Conversion of a C corporation to the LLC that is considered a partnership and is taxed as such would result in a massive tax bill. The higher bills come about as a consequence of the taxes attached to the liquidation or transfer of assets to the corporation and a further taxation of the movable property that are distributed to shareholders. In other words, this is the effect of double taxation; however, there may be several exemptions in case there are no inbuilt gains, or appreciation of assets as well no significant net operating losses. The second scenario is the one, which involves converting the C corporation to the LLC that is considered a corporation through the election (Hoffman, Raabe, Maloney, & Young, 2016).

The IRS has the discretion of looking at this conversion in two different ways: as a straight exchange of shares or as a largely tax-free F reorganization under Internal Revenue Code (IRC) Section 1036 and IRC § 368(a) (1) (F) respectively. The tax bills for this kind of conversion are lower, though, how they are calculated is not straightforward particularly for the later. Lastly, the conversion may be from the C corporation to the LLC that has a disregarded entity, and for most small business it involves transformation to the LLC with a single owner. Then it is considered by the IRS as a liquidation and the LLC carries the general taxes.

Advantages and Disadvantages of a Corporation over a Partnership

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Advantages of corporations over partnerships are the following: firstly, shareholders in the corporation are considered a separate entity from the business. Therefore, they are not liable for any corporate debts. As for the partnership, business owners are personally responsible for debts their activities incur. Secondly, corporations have savings on self-employment tax because earnings from the partnership are subject to that, but in case of corporations only salaries but not profits pertain to such taxes, which can turn into millions of savings yearly. Thirdly, the corporation has a continuous life and does not expire upon the death of its owners as in the partnership. Fourthly, raising capital is another consideration, and as for corporations there are many ways to do that. They can sell shares of stock, and investors can have the confidence that they are not liable for corporate debts. Lastly, transference of interests of the corporation is easier as they can be sold without interfering with the life of the business. On the other hand, the partnership cannot be transferred wholly since its assets, permits, and licenses have to be moved individually.

Some of the disadvantages include costs that are involved in launching the corporation, where initial formation fees, filing, and annual state fees are included. Secondly, there are many formalities that have to be considered in running the corporation. Corporate meetings and recording of minutes are mandatory, and even if adhering to these formalities may not be difficult, they are time-consuming. The partnership, however, can be run without formal organizing or operating procedures. Finally, shareholders in the corporation are obligated to pay for unemployment insurance taxes on their salaries whereas it is not required for owners in the partnership.

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