Series LLC Tax Treatment
A Series LLC is a newer, specialized type of LLC that essentially creates a holding LLC and subsidiary LLCs all in one entity. The 'master' LLC acts like any other LLC, except that it is also authorized to create 'series' inside it. Each series is a separate entity for liability purposes.
A Series LLC typically only has to file one tax return because the earnings and losses of the underlying series flow through to the master LLC. Furthermore, it only needs one bank account.
This makes a Series LLC great for holding multiple rental properties. It will save you a considerable amount of money on legal, accounting, and bookkeeping fees, and from having to open multiple bank accounts.
LLCs and Taxation
One of the benefits of using an LLC as a holding company is that an LLC allows maximum flexibility for choosing how it will be treated for federal income tax purposes.
The owner of an LLC can choose to be treated as either:
- A Limited Partnership;
- A C-corporation;
- An S-corporation; or
- A Sole Proprietorship.
Here are the advantages and disadvantages of each of the four ways in which your Series LLC can be taxed:
A Series LLC Treated as a Sole Proprietorship
The default tax treatment for an LLC is a sole proprietorship. However, only a single-member LLC can be treated as a sole proprietorship.
Sole proprietorships are not required to file separate tax returns and are considered disregarded entities by the IRS. The members of an LLC treated as a sole proprietorship report all the income and losses of the LLC on their personal income tax returns via Schedule C.
One of the primary advantages of having a Series LLC treated as a sole proprietorship is that you don't have to file a separate return, as you will with the other taxation methods. This is a huge benefit because this will save you time and money that might otherwise be spent on paying an accountant or preparing the additional tax returns yourself.
The disadvantages of having your Series LLC taxed as a sole proprietorship are:
- Sole proprietorships tend to get audited more often; and
- The owners of an LLC are required to pay self-employment taxes in addition to income taxes.
A Series LLC Treated as a C-corporation
In order for an LLC to be treated as a C-corporation, it must file IRS form 8832. A C-corporation is considered a separate entity from its shareholders by the IRS. Thus, a C-corporation files its own tax returns and pays whatever taxes the corporation owes via IRS form 1120.
The main problem with being treated as a C-corporation is the issue of double taxation. The IRS taxes corporate earnings as they are earned by the corporation and then again when they distributed to its shareholders as dividends.
Another disadvantage of C-corporation taxation is that their capital gains or not subject to a preferential tax rate. This is different than an S-corporation or partnership, where capital gains are subject to a special tax rate which is usually lower than the corporate tax rate.
A Series LLC Treated as an S-corporation
S-corporations are "pass-through" entities for Federal income tax purposes. A pass-through entity does not pay taxes, rather the S-corporation passes its income and losses through to its shareholders.
The shareholders of an LLC treated as an S-corporation report the earnings and losses of the S-corporation on their personal income tax returns. However, there are a few circumstances when an S-corporation may be required to pay taxes.
One such circumstance is when converting a C-corporation into an S-corporation when there are assets in the C-corporation that have appreciated. These appreciated assets may be subject to taxation.
An LLC must elect S-corporation taxation by filing IRS form 2553. However, in order to be taxed as an S-corporation, the LLC has to satisfy certain eligibility requirements, specifically, the LLC:
- Must be a domestic LLC (formed in the U.S);
- Must not have any corporations, partnerships, certain types of trusts, or non-residents aliens as members;
- Must not have more than 100 members or function as a financial institution, insurance company, domestic international sales corporation, or perform certain other business functions.
One disadvantage of being treated as an S-corporation is that if the LLC gains any new member who is of a prohibited type, the S-corporation election will be terminated, which may have serious tax implications.
On the other hand, S-corporation taxation avoids the double taxation that plagues a C-corporation. This is because the S-corporation passes on its economic activity to its shareholders. The shareholders of an S-corporation are generally not required to pay taxes on distributions they received from the S-corporation.
Another advantage of being treated as an S-corporation is that the members of an S-corporation can avoid having to pay self-employment taxes. This is because a member of an LLC that is taxed as an S-corporation can receive a reasonable salary that will exempt them from having to pay self-employment taxes on the LLC's profits.
A Series LLC Treated as a Partnership
Partnership taxation is the default tax treatment for a multi-member LLC. Partnerships are required to file a tax return using IRS form 1065. However, this is simply for informational purposes.
Like an S-corporation, the IRS considers a partnership a pass-through entity. This means that the income and losses of the partnership must be reported on the owners' personal tax returns.
But, unlike an S-corporation, an LLC taxed as a partnership, can also pass income and losses on to its owners, provided that these income or losses have had a substantial economic effect on the LLC.
On the other hand, the owners of an LLC treated as a partnership cannot be treated as employees and receive a salary for services performed for the LLC. This means that the owners of an LLC treated as a partnership may be required to pay self-employment taxes in addition to income taxes.
Note: The issue of self-employment taxes for the members of an LLC taxed as a partnership is very complicated. Therefore, you should speak with an experienced tax advisor for more detailed information on this issue.
Another major drawback of an LLC taxed as a partnership is that filing the tax return can be much more complicated than with other tax treatments. It is estimated that maintaining partnership records, and then preparing, assembling, and sending a partnership’s tax return can require as many as 100 man-hours.
For more detailed information regarding the taxation of a Series LLC and to find out which taxation option will provide your company with the most benefits, consult with an experienced business law attorney and speak with your tax advisor.