LLC Tax Advantages

The essential advantage of a limited liability company is that it provides pass-through treatment without taxation at the entity level, essentially partnership tax treatment, while shielding members from personal liability. Multiple member LLC's are treated as a partnership and file a US Partnership Tax Return Form 1065. Single Member LLC's can be treated as a Sole Proprietorship and are taxed on the member's 1040 Schedule C. Limited liability companies then provide the advantage of protecting its members from the liabilities of debts and obligations, similar to corporate shareholders. It should be noted, however, that this limited liability has been continuously eaten away, particularly in the area of environmental law, and it is not expected that limited liability companies would fare any better. If a limited liability company is properly structured, it will be treated as a partnership pass-through entity.

General Tax Classifications

Because a limited liability company is an unincorporated business entity, the Internal Revenue Service will not treat it as a corporation unless it has more corporate characteristics than non-corporate characteristics. The Entity Classification Election filed with the IRS can specify whether the LLC will be treated as a Corporation, Partnership or Proprietorship. Because these fundamental rules have been established over a long period of time where taxpayers tried to classify entities as corporations, and the Internal Revenue Service tried to compel pass-through entity, the regulations favor pass-through status. Treasury Reg. § 301.7701-2 lists the following six characteristics in determining whether a business is subject to corporate taxation:

(1) Associates

(2) An objective to carry on business and divide the profits

(3) Limited liability

(4) Continuity of life

(5) Free transferability of interest

(6) Centralized management