LLC Taxation Requires A Great Relationship With Your Accountant

We have discussed what an LLC (limited liability company) is and how to form an LLC, but how is it taxed at the federal level?

The simple question has a somewhat complicated answer.  The LLC is a relatively new form of business entity that combines features of both partnerships and corporate structure.  In 1997, the IRS clarified how an LLC would be taxed.  This is known as “check-the-box” taxation, as the LLC checks a box on a form.

A single-member LLC may elect to be taxed as either a C corporation or a sole proprietorship.  A multiple-member LLC may elect to be taxed as either a partnership or a C corporation.  So, in order to determine how an LLC is taxed, we need to discuss sole proprietorships, partnerships, and C corporations.

Sole Proprietorship:

A sole proprietorship is a business owned by a single, sole individual and is treated as the individual owner for tax purposes.  There is no tax return specific to the business entity.  The only tax return is the individual’s tax return with the income of the sole proprietorship reported on Schedule C.  The business income is then taxed at the individual’s tax rate.  Note that business income includes distributed net profits and retained earnings.  Finally, keep in mind that a sole proprietorship is responsible for paying self-employment tax.

Partnership:

A partnership is, in its most simplest form, two or more people work together to advance their business interest(s).  The partners share profits, losses, deductions, credits etc.  A partnership is not taxed; rather, income, losses, deductions, credits etc. “pass through” to the partners.  The partnership reports each partner’s share of income, losses, deductions, credits etc. to the IRS and each partner in accordance with the partnership agreement.  The partners then report their share on their own tax return, regardless if there was an actual distribution of income to the partner.

Note that along with the potential distributions of profits and losses, partners may also be provided guaranteed payments for their services or capital contribution to the partnership.  These guaranteed payments are ordinary income for the partner and deducted by the partnership as an ordinary business expense.  However, if the guaranteed payment is for personal services, the partner is liable for self-employment tax.

C Corporations:

A C corporation is what a person typically thinks of when the word ‘corporation’ is used.  A C corporation is so called because it is governed by Subchapter C of the Internal Revenue Code.

Unlike a sole proprietorship and partnership, a C corporation is a taxable entity.  In other words, the C corporation files its own tax returns separate from its shareholders.  Taxable income is calculated by the C corporation and the corporation pays tax.  There are various tax strategies in C corporation’s that this blog post will not address.  What a farmer or rancher should be aware of is that the C corporation is taxed as an entity, unlike the other business entities discussed in this post.

Conclusion:

All in all, this post is a very small look at the considerations in selecting a business entity for your farm or ranch operation.  If you want a more detailed discussion of various business entities, feel free to contact us.  And don’t forget, also contact your financial professional — they know taxes, after all!

I know what an LLC is … how do I form one?

We broadly touched upon what a limited liability company (“LLC”) is in the previous post but how does one go about forming an LLC?

Because an LLC is authorized under Nebraska’s statutes, the statutes must be followed to form an LLC.  What are the steps involved?

  1. Choose a name for the LLC.  Note that the name must include ‘Limited Liability Company’, ‘LLC’, or ‘L.L.C.’ so the public is aware that it is an LLC.
  2. File a Certificate of Organization with the Nebraska Secretary of State.  The Certificate of Organization must include the LLC’s name and address, as well as the name and address of the registered agent of the LLC.  The registered agent is the person or entity authorized to receive legal papers for the LLC.  You also want to indicate the nature of the business on the Certificate of Organization.  The filing fee is $100.
  3. You are required to publish notice of organization for three successive weeks in a legal newspaper of general circulation near the designated office.  The notice must include the name of the LLC, street and mailing address of the LLC’s office and registered agent, and if organized to render a professional service, the profession service its managers, members, professional employees, and agents are licensed or otherwise legally authorized to render in Nebraska.
  4. An LLC is also required to file biennial reports — reports filed once every two years with the Nebraska Secretary of State.  These are filed in odd-numbered years.  There is a filing fee and if a report is not filed, the LLC will be dissolved by the State of Nebraska.

Keep in mind that while an operating agreement is not required, it is highly recommended.

If you are thinking of an LLC as you begin your farm operation or as a mechanism to assist in business and estate planning, Legal Aid of Nebraska is here to help.  Just feel free to contact us!

What is an LLC?

If you read the back of the newspaper, I’m sure you have seen legal notices for the formation of limited liability companies.  In fact, some of those notifications may be for your neighbors.  So, what in the world is a limited liability company, or LLC?

The name alone, limited liability company, gives us some clues.  In an LLC, a person or persons contributes capital or assets to the company.  In return, the person or persons is not personally liable for the debts and liabilities of the LLC.  In other words, the extent of a person’s contribution to the LLC is the extent of the payment of debts and liabilities the LLC may incur.  This is the basis of ‘limited liability’.  This is the same limited liability a corporation has.

Unlike a corporation, however, an LLC has pass through taxation, or check-the-box taxation.  This is the same type of taxation a partnership has.  This means that any income of the LLC is treated as the income of the members of the LLC.  If the LLC is has only one member, the income or loss of the LLC is reported on the individual tax return of the member.  If the LLC has multiple members, each member receives a K-1 Form reporting the income distribution to the member.  This is the same form as a partnership.

An LLC may elect to be treated as a corporation for taxation purposes.  If that election is made, the LLC must choose between a traditional corporation (C-corp) or an S-corporation.  The details of that election is outside the scope of this blog post, but keep an eye out for future discussion.

An LLC has wide flexibility in determining how it operates.  While an LLC in Nebraska is not required to have a written operating agreement, it is highly recommended.  The operating agreement defines how the LLC is managed on a day-to-day and long-term basis, voting rights, who can bind the LLC to contracts, admission of new members, withdrawal/dissociation, distributions, amendment of the operating agreement, dissolution, transfer of LLC interests, and fiduciary duties.  Other issues can also be drafted into an operating agreement but the above are the big issues.  The operating agreement is private between the members of the LLC and is not required to be filed with a state agency when forming the LLC.

If you are considering an LLC as you begin your farming operation or as a mechanism in estate or business planning, feel free to contact us.  We’re happy to discuss the issues with you!