Michael Fitzsimmons CPA

San Diego, CA

(619) 757-1500     info@fitz-cpa.com

Limited Liability Company (LLC)

A Limited Liability Company (LLC) is similar to a corporation in that it provides liability protection to the business owner(s). However, since it is taxed as a partnership, the company owes no federal income tax and therefore avoids the double-taxation of business profits. An LLC’s net income is subject to federal income tax just once: on the owners’ personal tax returns. Other considerations:

  • Must pay $800 minimum tax to California, the same as any business entity that provides liability protection.
  • More flexible than an S-corporation in allocating items of income and deduction among owners.
  • Unlike a Limited Partnership (LP), all owners get liability protection.
  • Generally, all income is subject to Self-Employment tax. Careful LLC tax planning can avoid self-employment tax on some income under some circumstances.
  • Can elect to be treated as a corporation or S-corporation for income tax purposes.
  • Subject to California “LLC Fee” of up to about $12,000 per year, in addition to the $800 annual tax. The LLC Fee is a tax not on income, but on gross revenues before deductions, so is owed even when the business generates a net loss. For this reason, LLC’s are less popular in California than in other states.
  • Operating Agreement is a crucial document and must be drafted and amended with consideration to tax and accounting implications.
  • Members (owners) may be treated differently for payroll/employment taxes than for income taxes.

Items of Note

Recent Tax Court case Garnett (132 T.C. No. 19) established new tax law, new legal precedent, that LLC units are not the same as limited partnership interests for purposes of federal tax law. The case clarified that all of the exceptions to the passive activity rules may be applied to LLC ownership interests, not just those permitted to limited partnership interests. Although specifically about classification of income as active or passive, this determination also affects characterization of income as subject to self-employment tax. The case effectively prevents taxpayers from arguing that LLC income is not subject to self-employment tax under the theory that LLC interests were equivalent to limited partnership interests, which are by regulation generally exempted from self-employment tax.

IRS recently allowed several Limited Liability Companies to make the election to be taxed as a corporation after the election period had expired: Private Letter Rulings PLR 201004018 & 201004019. Since private letter rulings are not legal precedent under federal tax law, these cannot be relied upon by other taxpayers, but demonstrate that the IRS continues to grant late LLC entity classification elections. Generally, an LLC must make the election no more than 75 days after the beginning of the tax year for which it is to take effect. Taxpayer may request a ruling by the IRS by showing that there was reasonable cause for not making the election on time.

Business Tax Strategies

Please refer to these pages for more tax savings ideas:

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