I'm confused - just how is a limited liability company taxed for federal purposes?

I'm asked this question a lot. I suspect it's because there are many possibilities.

When thinking about a limited liability company (LLC), find out if it's owned by:

• One natural person (one, single owner),
• Husband and wife (husband-wife qualified joint venture organized as an LLC), or
• Multiple persons (multiple member LLC).

Why? The taxation options available the LLC are linked to the ownership.

Some LLCs must be taxed as corporations - they simply have no choice. These are few; you are unlikely to run across any.

The federal government does not recognize the LLC as a classification for tax filing purposes. Rather, it's taxed as a corporation (including S corporation), partnership, or sole proprietorship.

The LLC chooses how it wants to be taxed federally by filing Form 8832 (Entity Classification Election).

One (single) owner LLC:

The one owner LLC makes the choice in its first taxable year to be taxed as either a corporation, or as a 'disregarded entity' (translating to a sole proprietorship). Most likely it will choose 'disregarded entity' status. If it chooses corporate taxation, it may be able to elect S corporation tax status providing it's eligible to do so.

Multiple member LLC:

The multiple member LLC (more than one owner) makes its choice as well - corporation or partnership. Most choose partnership and many of the reasons are tax based. Could it choose corporation and then elect S tax status? Yes, but seem redundant on its face.

Husband-wife qualified joint venture as LLC:

The husband-wife qualified joint venture as LLC almost always selects partnership taxation. But it could choose disregarded entity status filing two Schedules C (one for each the husband and wife) within the joint Form 1040. The ownership need not be equal.

Keep this in mind - both the corporation and the LLC afford the owner a limit to their personal liability. The term 'disregarded entity' refers to its taxation classification only; no adverse effect on the personal liability protection.

Can the LLC change its tax classification? Yes - it does so using Form 8832. There are some restrictions, but doable.

Let's consider the income taxes under each scenario.