Is it better to be classified as a sole-proprietorship or partnership for tax purposes with a LLC?

Asked over 2 years ago - Huntingtown, MD

My parents and I just formed an LLC in Maryland. We raise Livestock and crops for Agriculture purposes. I am confused on which way would be better for tax purposes. We obtained a Federial EIN number but told them that there were mulitple members to the LLC because we all signed the Articles of Organization form sent to the Maryland SDAT. However I want to basically know if I should have told the IRS that there is only one owner to the LLC and therefore change the members of the LLC with the Maryland SDAT. If anyone could let me know that would be greatly appreciated... Thanks.

Attorney answers (5)

  1. Nicholas Bernard Proy

    Contributor Level 13

    5

    Lawyers agree

    Answered . You should consult with a Maryland attorney regarding this situation. Aside from the actual LLC and Tax ID numbers, you also need to think about succession planning when planning out your business.

    All of that aside, an LLC is a pass-through entity, so the taxes are paid either as personal income or partnership income. One thing you will also want take into consideration is Maryland's business personal property tax.

    This is not legal advice. I am not your attorney. You should consult with an attorney licensed to practice in your... more
  2. Jeffrey David Katz

    Contributor Level 9

    3

    Lawyers agree

    Answered . It depends. LLC's treated as disregarded entities don't qualify for preferential tax treatment with respect to social security and Medicare contributions.

    Disregarded Entity
    A disregarded entity, also called a pass-through entity, is one that is distinct from its owner for some purposes, but not when it comes to taxes. Sole proprietorships and partnerships, for example, are disregarded entities because the owners of these corporations report the business's income on their personal tax returns. Corporations are generally an example of a business entity that is not disregarded -- except for S corps and REITs, a corporation generally pays taxes on its profits before distribution to shareholders.

    LLC Classification
    Under the IRS rules, an LLC is classified by default as either a sole proprietorship, if it has only one member, or a partnership, if has more than one member. This means that most LLCs are disregarded entities for federal tax purposes. Nevertheless, an LLC can elect to be taxed as a corporation by filing Form 8832. Upon the effective date of the election, the company loses its status as a disregarded entity. An LLC that is taxed as a corporation, however, may qualify as an S corp, in which case it would again be a disregarded entity.

    Employment Taxes
    Effective 2009, the IRS has made some changes to the disregarded entity status of single member LLCs. While those being taxed as sole proprietorships continue to be disregarded entities for income tax purposes, the LLC is now the taxpayer for employment taxes and certain federal excise taxes such as alcohol, tobacco and firearms. This means the LLC will have to have an EIN and bank account in its own name if it is subject to these taxes.

    Self-Employment
    One consequence of owning a disregarded entity LLC is that it most likely makes you liable for self-employment tax. In essence, however, this is only a shifting of what would ordinarily be the employer's share of Medicare and Social Security tax to the owner of the business. If you receive more than $400 from your disregarded entity LLC, you will have to pay self-employment tax on your personal Form 1040.

    Jeffrey D. Katz, Esq. does not intend this to be construed as legal advice, but as general discussions of legal... more
  3. Bradley Richard Thompson

    Contributor Level 8

    4

    Lawyers agree

    Answered . It depends on what your objective is. From a corporate perspective the LLC provides a liability shield, protecting the personal assets of the owners. This feature does not change if there is one or many members. If the business arrangement is that you and your parents are all owners of the business then it probably makes sense for you all to be members of the LLC.

    The difference between one member versus multiple members is really really the tax treatment. For federal tax purposes the business will be treated as being run through a partnership with your parents and you as partners. This should not increase the tax liability (income of the partnership is taxed in the hands of the partners) but will result in additional compliance requirements. If there was a single member of the LLC the LLC would be entirely disregarded for income tax purposes (but not for all federal tax purposes, e.g., payroll withholding would still be applicable to the LLC as an entity).

  4. Martin L Bearg

    Contributor Level 14

    4

    Lawyers agree

    Answered . I would concur with what my colleagues have stated. As a multi-member LLC you are a partnership. This gives you added protection for if animals run loose and cause damage, it is only the assets of the LLC, and/or distributions to which you are entitled to receive from the LLC that the creditor can attach if not covered by insurance.

    A judgment creditor cannot become your partner, especially if you have a restrictive covenant in either the Articles/Certificate of Formation or a Members' Operating Agreement.

    As a sole proprietorship, which a single member LLC is, the creditor can seize the Company.

    Most LLC's that elect to become corporations elect to be S Corporations to enable payroll to be paid by the corporation rather than individual partners to pay estimated taxes, but an S Corporation has many limitations/less flexibility than an standard LLC. You may wish to speak with an expert in farm accounting. There is a colleague of mine in Livingston, NJ who is an attorney as well as a CPA and has many farmer clients in MD, VA, DE and the area. His name is Allen Nimensky. He can be reached at 973-533-9200, x-106. Neither he nor I can give you advice regarding MD law, but he can advice regarding how to best establish this new entity for Federal Income Tax purposes. You might, for example, find it wise to create a corporation that is the management company of the LLC, which will allow you to pay payroll and to create retirement accounts, assuming profitable years.

    If you found this answer helpful, please indicate so below.

    The foregoing is not intended to be legal advice upon which you may rely as I have not been retained for this purpose.
  5. Dana Whitney Atchley

    Contributor Level 20

    4

    Lawyers agree

    Answered . I don't practice in Maryland, so the disclaimer about not relying on my answer as it concerns Maryland law goes doubly; however, as a matter of federal tax law, since the facts are that you and your parents formed this LLC, stated to the IRS (under penalties of perjury if this was stated on the Form SS-4 you used to obtain the EIN) that there were multiple members, and stated to the Maryland State gov't that there were multiple members, you could very well commit tax fraud if you had told the IRS that there was only one member.

    I won't advise you to go back and change your answers now unless your parents in fact withdraw from the LLC as members (which should be done in writing, signed by everyone involved, and should involve some sort of payment or consideration paid to them to withdraw from the LLC).

    However, because you've already stated to IRS and Maryland that the LLC had multiple members and was therefore a partnership, in order to cause the LLC to revert to a single-member LLC (and thus cease to be a partnership and become a so-called "disregarded entity"), you will have to file a partnership tax return for a very short tax year (basically, from the date you formed the LLC to the date on which your parents formally withdraw as members of the LLC). The mechanics are a little bit complicated, since this would also be a final partnership return for the LLC, and the change and the reason for it should be disclosed to the IRS (and to Maryland) on the returns, but it would be the proper way to change the LLC from a multi-member LLC (and thus a partnership for tax purposes) to a single-member LLC (and thus, by default, a disregarded entity for tax purposes).

    Alternatively, you could form a second LLC yourself and dissolve the LLC you formed with your parents.

    I would strongly urge you to discuss the situation with your accountant and/or a tax attorney because, although it seems a small enough matter, the potential for problems down the road is big enough that it should be done properly, and certainly not on your own just on the strength of some posts you got online for free from some attorneys you've never met.

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