Vernoia, Enterline + Brewer, CPA LLC

Posts tagged ‘llc’

Learn about Tax Benefits for Education

The beginning of the school year is a good time for a reminder of the tax benefits for education. These benefits can help offset qualifying education costs. (more…)

IRS auditors place more focus on partnerships

IRS officials, including Faris Fink, then Commissioner of the Small Business and Self-Employed Division,  announced in 2013 that the IRS would increase its scrutiny of partnership entities. Indeed, the IRS’s audit statistics for 2014 have shown that Fink’s prediction was accurate. While the overall audit rate for all types of businesses fell from 0.61 percent in Fiscal Year (FY) 2013 to 0.57 percent for FY 2014, the audit rate for partnerships has increased.

The IRS’s recently released Winter 2015 Statistics of Income Bulletin underscores why IRS officials are becoming increasingly concerned about partnerships. The bulletin-which highlights several trends including partnership numbers-shows that the number of partnerships has been growing recently by 3.1 percent, year over year. Not only this, but the number of partners, the level of assets, and the total gross receipts received during this period all increased.

Passthrough entities like limited partnerships and limited liability companies (LLCs) have become an increasingly popular way of organizing businesses. (The IRS reported that domestic limited liability companies (LLCs) made up 65.3 percent of all partnerships.) Domestic limited partnerships-although representing only 12 percent of all partnerships-but reported 33.4 percent of all partnership profits (the largest figure of all types of partnership entities and the largest share of partners.

While incorporation was once the only means of shielding individual directors and officers from individual liability for the corporation’s obligations, passthrough entities can now be structured in such a way as to protect the individual partners from liability for the company’s debts. In addition, passthrough entities like partnerships can still enjoy the benefits of passthrough taxation. Corporations, on the other hand, are generally taxed twice: once at the entity level, and again when profits are distributed to the individual shareholders.  S corporations are the exception there, being taxed only once at the owner/shareholder level and sharing many similarities with partnerships.

Partnership Statistics

The IRS’s Winter Statistics of Income Bulletin reported that the number of partnerships filing tax returns grew 3.1 percent (from 3,285,177 to 3,388,561) between 2011 and 2012. Since 2003, the number of partnerships has grown at an average annual rate of 3.9 percent. The Bulletin also reported that the number of partners has grown during each of the last nine years, increasing 3.9 percent (from 24,389,807 to 25,333,616) between 2011 and 2012. Partnerships with fewer than three partners made up more than half (55.9 percent) of all partnerships, the IRS reported. Partnerships with 100 or more partners, however, accounted for almost half (47.3 percent) of all partners in 2012.

For 2012, partnerships passed through $1,400.8 billion in total income minus total deductions available for allocation to their partners, the Bulletin reported. This amount represents a 43.4-percent increase from 2011 when partnerships passed through $976.9 billion. In contrast with Tax Year 2011, when individual partners received the largest portion of passthrough income, partners classified as partnerships received the largest portion of this income for 2012.

Need for Partnership Audit Reform

Tax administrators, including IRS Commissioner John Koskinen, have expressed concern that this growth in more profitable, more complex partnerships has created a dire need for reform of the current rules for auditing partnerships. The rules, they say, were legislated before partnerships became so complex, administrators say, and now the obstacles to the IRS’s efficient oversight of large partnerships in particular leaves room for a large tax compliance gap. For example, a report issued in September 2014 by the Government Accountability Office (GAO) revealed that the IRS’s field audit rate of large partnerships-defined by the GAO as having $100 million or more in assets and 100 or more direct and indirect partners-was less than one percent for FY 2012.

Several lawmakers, including President Obama, Rep. Dave Camp, R-Mich., and Sen. Carl Levin, D-Mich., have issued tax reform proposals that include changes for audits of partnership entities, but most of these have fallen flat in the debating room. Thus, the IRS is doing what it can without Congressional help, IRS officials stated during a recent tax law conference in Washington, D.C. Nancy Knapp, Associate Area Counsel, IRS Large Business & International Division (LB&I), stated that the IRS planned to increase audits of passthrough entities in the future. This increased focus, she said, stemmed from the IRS’s recognition that an estimated 191,000 of 296,000 L&I taxpayers are passthrough entities that generate revenue the IRS has up until now practically ignored.

FAQ: How are LLCs taxed?

An LLC (limited liability company) is not a federal tax entity. LLCs are organized under state law. LLCs are not specifically mentioned in the Tax Code, and there are no special IRS regulations governing the taxation of LLCs comparable to the regulations for C corporations, S corporations, and partnerships. Instead, LLCs make an election to be taxed as a particular entity (or to be disregarded for tax purposes) by following the check-the-box business entity classification regulations. The election is filed on Form 8832, Entity Classification Election. The IRS will assign an entity classification by default if no election is made. A taxpayer who doesn’t mind the IRS default entity classification does not necessarily need to file Form 8832.

“Check-the-Box” Election

An LLC with more than one member can elect:

  • Partnership
  • Corporation
  • S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

An LLC with only one member can elect:

  • Disregarded entity
  • Corporation
  • S corporation (accomplished by electing to be taxed as a corporation, then filing an S corporation election)

The IRS will assign these classifications if no entity election is filed for an LLC (the default rules):

  • any business entity that is not a corporation is classified as a partnership
  • any entity that is wholly-owned by a single person will be disregarded as an entity separate from its owner (taxed as a sole proprietorship).

Typically, an LLC with more than one member will elect to be taxed as a partnership, whereas a single-member LLC will elect to be disregarded and taxed as a sole proprietorship.

If you have any questions relating to LLCs, their benefits, drawbacks, or their treatment under the Tax Code, please contact our offices at (908) 725-4414.

FAQ: Pros & cons of LLCs?

When starting a business or changing an existing one there are several types of business entities to choose from, each of which offers its own advantages and disadvantages. Depending on the size of your business, one form may be more suitable than another. For example, a software firm consisting of one principal founder and several part time contractors and employees would be more suited to a sole proprietorship than a corporate or partnership form. But where there are multiple business members, the decision can become more complicated. One form of business that has become increasingly popular is called a limited liability company, or LLC.

The LLC combines several favorable characteristics of a traditional partnership, in which all members are entitled to participate in the management and operation of the business, with those of a corporation, in which the owners, directors, and shareholders are generally shielded from liability for the corporation’s debts. The means that in an LLC, just as in a corporation, the personal assets of the business owners’ would generally be protected if the business failed, lost a lawsuit, or faced some other catastrophe. Members are only liable to the extent of their capital contribution to the business. In addition, members can fully participate in the management of the business without endangering their limited liability status.

When filing season begins, the profits (or losses) from the LLC pass through to its members, who pay tax on any income when filing their individual returns. In other words, income from the LLC is taxed at the individual tax rates. Income from corporations, on the other hand is taxed twice, once at the corporate entity level and again when distributed to shareholders. Because of this, more tax savings often results if a business formed as an LLC rather than a corporation.

Taxpayers should note, however, that Congress recently increased the top marginal individual income tax rate to 39.6 percent, has placed a .09 percent additional Medicare tax on wages over $200,000 (single taxpayers), and has imposed a 3.8 percent net investment income tax on higher-income taxpayers. At the same time, there is strong talk among members of both political parties of lowering the corporate rate from the current 35 percent to something around 28 or 25 percent to make the United States more competitive with foreign nations. If this happens, many highly profitable LLC businesses may need to rethink their situation and consider switching to a corporate form.

Forming an LLC involves many requirements, but the benefits can be substantial. Please call our office at (908) 725-4414 if you have any questions.

What is a limited liability company?

A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS’s “check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing “S Corporation” tax status under the Internal Revenue Code.