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LLC May be the Wrong Choice Part 2

Richard Chapo, Attorney

Part 2. Read LLC May be the Wrong Choice Part 1

The IRS rejects the filing.

Why? Well, there is only a single owner of the LLC, so how can a partnership tax return be filed? The IRS is correct in asserting that it cannot. You would need a second party to make it work.

At this point, things can get real nasty. Since the IRS views the partnership as invalid, it is going to require our single owner to treat the business as a sole proprietorship. This will require the payment of the 15.3 self-employment tax and usually the re-filing of the personal tax returns of the owner since the business tax information must now be filed on his or her Schedule C. You may also have to pay penalties and interest on any amount due.

Before you start complaining about the IRS, you should know that the position it is taking is entirely correct. The states are the responsible parties in this mess. Each state controls the laws regarding creating business entities within its boundaries. Despite the self serving statements of politicians about helping small businesses, the primary purpose of these laws is to generate fees. In California, each entity has to pay an annual $800 fee for the “privilege of doing business” in the state. This is how something like a single owner LLC can come into existence regardless of tax law or the position of the IRS.

Is there any strategy for avoiding this problem? Yes. Many small businesses are looking to “S” corporations instead of LLCs when there will be only one owner. The IRS treats these entities entirely different and one usually ends up in a better situation from a tax perspective. Make sure to speak with your CPA or tax professional regarding the options applicable to your specific situation.

About the Author

Richard A Chapo, Esq., is the lead attorney and owner of SanDiegoBusinessLawFirm.com. He provides legal services in the fields of business entity formation and internet law to large and small California businesses.

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LLC May be the Wrong Choice Part 1

Richard Chapo, Attorney

If you are going to open a business these days, you really need to protect yourself by forming a business entity. Lawsuits are a fact of life and the proper business entity will build a shield between the debts of the business and your personal assets.

Corporations and limited liability companies are the two most popular choices for small businesses. There are numerous differences between the entities, but the lack of record keeping and formalities has made the “LLC” a very popular choice for many small business owners. This choice can, however, lead to problems if only one person owns the entire entity.

To understand the potential problem, we first have to step back and look at the bigger picture. The touted advantages of an LLC are threefold. First, it provides you with asset protection similar to a corporation. Second, it does not require you to go through the formalities of record keeping, meeting and so on as required with a corporation, to wit, it is more informal. Finally, the LLC has the inherent advantage in that it can be taxed as a partnership, which avoids the double taxation problem that exists with a corporation. This last advantage is where we start running into problems.

As you know, the IRS controls the rules and regulations applicable to federal tax law. For tax purposes, the IRS defines a partnership as two or more individuals [or businesses] pursuing a profitable venture. This is also the legal definition. The key thing to focus on is the numeration – two or more. For there to be a partnership for tax purposes, two or more groups have to be involved.

Now, let’s return to our LLC owned by a single person. The advantage of being taxed like a partnership is a big advantage to being an LLC. So, what happens when you file your partnership tax return after your first year of being in business as an LLC?

Part 2 will be published tomorrow.

Richard A Chapo, Esq., is the lead attorney and owner of SanDiegoBusinessLawFirm.com. He provides legal services in the fields of business entity formation and internet law to large and small California businesses.

Related Topics: Business, Entrepreneurship, Legal, Money/Finance    No Comments