Income taxation of Texas limited liability companies: an overview
Many new business owners choose to organize their businesses as limited liability companies because this form of business provides some of the best qualities of a corporation and a partnership. An LLC offers its members considerable tax flexibility. A College Station Texas business attorney can provide you with the details, but here is an overview.
The IRS will treat an LLC as either a partnership (or sole proprietorship), or corporation, depending on which the members the elect.
Pass through or disregarded entity treatment
If the LLC has at least two members, unless they agree otherwise, the LLC is treated as a partnership. As a “pass through entity,” the LLC does not pay federal income taxes. The business has to file a return reporting its income and expenses (Form 1065), but the members report their share of the business taxable income (or loss) on their personal returns and pay taxes on it at their individual rates.
LLC members usually decide to divide up the business's profits and losses among them in proportion to their capital contributions, although they are not legally required to do so.
If the LLC has only one member, it is a “disregarded entity,” just like a sole proprietorship. The member reports the business's income and expenses on a Schedule C with his or her own tax return and pays any taxes that are due on income from the business.
If the business operates at a loss, members may be able to deduct the loss from other income, subject to limits imposed by the at-risk and passive loss rules. In general, you can deduct business losses only up to the amount you have invested in the business. Additional limits apply if you don't materially participate in the business.
Election to be taxed like a C corporation
The members (or sole member) of an LLC can elect to have the business taxed like a C corporation. This means that the LLC will pay taxes on its taxable income. The possibility for double taxation exists if the LLC pays its members a dividend. The money is taxed once to the LLC as profits and again to the members on distribution.
Most of the time, pass through taxation yields the most savings. Sometimes splitting the income between the business and its members (by paying out some of the profits to the members as salary and bonuses and retaining some of the profits in the corporation) will result in lower overall taxes. Also, choosing corporate-type taxation can provide favorable treatment for fringe benefits. It's a good idea to get advice from a professional tax advisor before deciding which tax treatment to choose.
For professional advice from an experienced College Station, Texas business attorney
For guidance in establishing an LLC or other type of business entity, contact the College Station, Texas business attorneys at the Peterson Law Group. Call us today at 979-703-7014 for an appointment.