If you’ve been following our blog for the past couple of Fridays, you know that we’re covering four basic tax tips to consider when forming a new entity. If you missed the first two, read up on the C-Corporation and S-Corporation.
The four considerations we’ve been covering are:
- Pass through of gains
- Pass through of losses
- Transfer of assets to the entity, and
- Transfer of assets from the entity
Today we will cover the LLC. Before we get into the four considerations, it is important to make one distinction: the difference between an entity’s legal treatment and its tax treatment. An LLC is a type of limited liability entity (hence, Limited Liability Company) that allows the owners protection from legal liabilities. (This differs from a partnership, which is a contractual relationship between the parties, and from a Corporation, which is a creation of a state’s corporate law.) An LLC can elect its tax treatment and be taxed as if it were a Corporation or as Partnership. The distinction is made clearer below.
1. Pass through of gains
The default treatment of an LLC is to be treated as a Partnership. Any gains had by the entity will automatically be passed through to a shareholder’s personal income statement. That means that the entity doesn’t pay income taxes, only shareholders. This is similar to the treatment of the S-Corp, but with fewer restrictions. A member of an LLC or a Partnership can contract with the other members as to how the gains are allocated and distributed to the shareholders.
2. Pass through of losses
Again, the default treatment of an LLC is to be treated like that of a Partnership. Any losses will pass through to a shareholder’s personal income statement. Losses can be allocated according to the terms of the operating agreement.
3. Transfer of assets to the entity
An LLC differs from both a C-Corp and S-Corp in this respect. A transfer of assets to an LLC is not a taxable event, regardless of the amount of control owned by the shareholder transferring the assets. This could potentially make starting your new company less expensive than with other entity types, especially when there are multiple shareholders.
4. Transfer of assets from the entity to shareholders
When an LLC decides to transfer assets to a shareholder, this event is not usually taxable. Either upon distribution or liquidation a shareholder is responsible for the taxes, if any have even arisen.
Overall, an LLC is a great tax efficient way to get your company started. In most cases there will not be a tax on transferring assets to and from the company. There is also no double taxation of profits, thus saving the shareholders money. Additionally, if there is a loss, a shareholder may benefit from a tax reduction.
Since there are different on going requirements for an LLC than for a Corporation, start here to consider any additional steps you may need to take.