Federal Tax Classifications for Business Entities

For federal tax classification purposes, a business is classified as either a "business entity," which is any entity recognized for federal tax purposes; or a "disregarded entity," which is any entity not recognized or treated separate from its owner for tax purposes. The most common federal tax business entities include a C-Corporation, S-Corporation, and Partnership. Various rules under the Internal Revenue Code determine how a business is treated for federal tax purposes. The default tax classification for a corporate entity is a C-Corporation. Alternatively, a corporation can elect to be taxed as an S-Corporation by filing Form 2553 with the IRS and meeting certain requirements. A single-member limited liability company is the only state-formed entity eligible to be classified as a disregarded...

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Self-Employment Tax Avoidance for LLC Members

In addition to the income tax, sole proprietors and partners in a partnership must pay self-employment tax on net self-employment earnings. This tax is imposed on "active" trade or business income, as opposed to "passive" income from rents, interest, dividends, capital gains, and income of a limited partner in a partnership. Corporations pay tax at the corporate level and accordingly, corporate net income is not subject to self-employment tax. As I wrote previously, S-Corporation earnings flow through to the individual shareholders' personal income tax returns and also avoids self-employment tax. A special set of rules applies to income generated by LLCs taxed as partnerships. These rules come from Prop. Reg. 1.1402(a)-2(h)(2). Technically, these regulations are not binding since the IRS...

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