The following article was written by The Editorial Staff at TheTaxBook and contributed for use on the TaxSlayer Pro blog.
Business taxes are arguably the most complex type of taxes you will file as a tax preparer. We’ve gathered all the basics of LLCs so you can brush up on your business tax knowledge and prepare to file your clients’ taxes.
What are single-member LLCs?
An LLC with one member is treated as a disregarded entity by default, meaning the entity is not recognized as a separate entity from its owner. The LLC’s activities should be reflected on its owner’s (your client’s) federal tax return under their taxpayer identification number. If the owner is an individual, the activities of the LLC will generally be reflected on:
- Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship),
- Schedule E (Form 1040), Supplemental Income or Loss, or
- Schedule F (Form 1040), Profit or Loss from Farming.
If the owner of a single-member LLC is an individual that operates a trade or business, net profit is reported on Schedule C. The profit is subject to self-employment in the same manner as a sole proprietorship.
If a corporation or partnership owns the single-member LLC, the LLC’s income should be reflected on the corporation or partnership’s federal income tax return.
Taxpayer identification number
For federal income tax purposes, a single-member LLC classified as a disregarded entity generally must use the owner’s Social Security Number (SSN) or EIN for all information returns and reporting related to income tax. For example, if a disregarded entity LLC owned by an individual is required to provide Form W-9, Request for Taxpayer Identification Number and Certification, the Form W-9 should provide the owner’s SSN or EIN, not the EIN of the LLC.
However, for employment tax and certain excise tax requirements, the EIN of the LLC must be used. Note: If a single-member LLC is not otherwise required to obtain an EIN but needs an EIN to open a bank account or to comply with state laws, the LLC can apply for and obtain an EIN. An LLC applies for an EIN by filing Form SS-4, Application for Employer Identification Number.
Change in default classification
If a single-member LLC classified as a disregarded entity acquires an additional member, it becomes a partnership under default rules.
What are multiple-member LLCs?
By default, an LLC with two or more members is treated as a partnership for federal income tax purposes. In this case, the LLC files Form 1065, U.S. Return of Partnership Income.
What is a member manager?
A member manager is any owner of an interest in the LLC who, alone or together with others, has the continuing authority to make management decisions necessary to conduct the business for which the LLC was formed. Only a member manager of an LLC can sign the partnership tax return. If there are no elected or designated member managers, each owner is treated as a member manager.
Change in default classification
If the number of members in an LLC is reduced to only one member, the LLC becomes a disregarded entity under default rules.
What are the state default rules?
LLCs are created and governed under each individual state’s laws, and each state will have its own set of default rules.
Some states have default rules that determine issues such as voting rights of the members or allocation of profits in the absence of an operating agreement. For example, an LLC member with 70% of the ownership interest may believe they could outvote the other members concerning LLC operations. Still, some state rules give owners an equal vote regardless of ownership interest by default. A similar situation can happen with regard to the allocation of profits. Even though it might not be required, a comprehensive LLC operating agreement should be drafted per state law to ensure the LLC complies with state rules.
The information in this article is up to date for tax year 2020 (taxes filed in 2021).