Chapter 11 Federal Income Tax Issues

Chapter 11 Federal Income Tax Issues2018-11-17T10:57:11+00:00

Section 11.1 IRS Employer Identification Numbers

The company should get an employer identification number (EIN) from the IRS. It will need the EIN to open a bank account in the name of the company, to file a tax return or to make a tax deposit. Any member of a member managed LLC or any manager of a manager managed LLC can obtain the EIN from the IRS.

Although the IRS does not require an EIN for a company taxed as a sole proprietorship (a single member LLC or an LLC owned only by a husband and wife as community property) if the company does not have any employees, I recommend that you get a EIN for the company so that you will not have to give your social security number to third parties the company deals with such as the company’s bank, vendors and independent contractors. If you use your social security number for your company taxed as a sole proprietorship, you increase the risk that somebody may obtain your SSAN and steal your identity.

The EIN is the LLC’s permanent number and can be used immediately for most of the company’s business needs, including: opening a bank account; applying for business licenses; and filing a tax return by mail. However, no matter how you apply (phone, fax, mail, or online), it will take up to two weeks before the LLC’s EIN becomes part of the IRS’ permanent records. You must wait until this occurs before the LLC can: file an electronic return, make an electronic payment, or pass an IRS Taxpayer Identification Number matching program.

Section 11.2 How to Get a Employer Identification Number for Your LLC

The following applies only to people who purchased Silver or Gold LLC packages and Bronze LLC purchasers who paid extra for our EIN service.

Although you hired us to get your LLC’s EIN, it is actually easier for you to complete the IRS’ online EIN wizard to get the EIN than it is to fill out IRS Form SS-4. We cannot get the EIN unless a person associated with the LLC fills out the SS-4, signs it and sends it back to us.

Your LLC’s responsible person must complete and sign and return an IRS Form SS-4 to us before we can get the EIN. A member or manager of the LLC must go to our web page called “IRS Form SS-4” and follow the instructions. This page explains how to complete the IRS Form SS-4 and return it to us. This form authorizes our legal assistant to contact the IRS on behalf of the LLC and apply for the EIN.

If you don’t want to complete the IRS Form SS-4, go to the IRS’ online EIN wizard and get the EIN yourself.  A responsible party must apply for the EIN for the LLC.  The “responsible party” is the person who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage or direct the entity and the disposition of its funds and assets. The ability to fund the entity or the entitlement to the property of the entity alone, however, without any corresponding authority to control, manage, or direct the entity (such as in the case of a minor child beneficiary), does not cause the individual to be a responsible party.

When the LLC’s EIN is displayed on the IRS’ web page be sure to write down the employer ID number and print the page for your records. Keep the EIN in a safe place.

Section 11.3 How Non-U.S. Citizens Get an EIN for Their LLC

If you are a not a citizen of the U.S. and a nonresident of the U.S. the IRS does not allow us to assist you in getting an EIN.  Nor can you use the IRS’ online EIN wizard.  International applicants may call 267-941-1099 (not a toll-free number) 6:00 a.m. to 11:00 p.m. (Eastern Time) Monday through Friday to obtain an EIN for their LLC. The person making the call must be authorized to receive the EIN and answer questions concerning the Form SS-4, Application for Employer Identification Number. For an explanation of how to complete the form read “How to Complete IRS Form SS-4.”

Section 11.4 How to Get Your LLC’s EIN if You Lose It

If you lose your EIN, call (800) 829-4933 and select EIN from the list of options. Once connected with an IRS employee, tell that person that you received an EIN from the Internet but can’t remember it. The IRS employee will ask the necessary disclosure and security questions then give you the number.

Section 11.5 Federal Income Taxation of LLCs

As you know, I am not advising the company or any member with respect to any federal or state tax issues concerning the company, its business and activities or the Operating Agreement. The company and all members should consult with their accountant(s) / tax advisor(s) with respect to all company and member activities (preferably in advance of taking action) that may have federal and state tax consequences, including reviewing the proposed Operating Agreement.

The new LLC may choose how it will be taxed for federal income tax purposes. Subject to certain limitations, an LLC may be classified for federal income tax purposes as: (i) a sole proprietorship (single member LLCs), (ii) a partnership (unless the LLC has only one member), (iii) a C corporation, or (iv) an S corporation. Whether an LLC can select a particular federal tax classification depends on the number and type of members.

By default, a domestic LLC with only one member or only two members who are married and own their interests as community property is disregarded as an entity separate from its owner and must include all of its income and expenses on the owner’s tax return (for example, Schedule C of IRS Form 1040). Also by default, a domestic LLC with two or more members is treated as a partnership unless it is owned by two people who are married and own the LLC as community property.

A single member LLC may elect to be classified as a sole proprietorship (if the member is a person) or a disregarded entity (if the member is an entity), a C corporation or an S corporation. Multi-member LLCs may elect to be taxed as a partnership, C corporation or S corporation. The LLC, however, may not elect to be taxed as an S corporation unless it meets all requirements applicable to S corporations. If the LLC does not elect its classification by filing IRS Form 8832, the IRS assigns a default classification of partnership (for multi-member LLCs) sole proprietorship (for a single member LLC if the member is a person) or a disregarded entity (for a single member LLC if the member is an entity).

Even though it is owned by two members, IRS Revenue Procedure 2002-69 says that an LLC that is owned solely by a husband and wife as community property may be taxed as a sole proprietorship or as a partnership. The couple may elect either form of taxation. The IRS will accept the married couples’ choice to be taxed as a sole proprietorship or as a partnership.

In general, the difference between being taxed as a corporation and being taxed as a partnership is that partnerships are not taxpaying entities and corporations (other than S corporations) are. The profits, losses and other tax items of an LLC taxed as a partnership are passed to the members of the company prorata according to their ownership and included on the members’ federal income tax returns. By electing to be taxed as a partnership for federal income purposes, a multi-member company can avoid the double tax that can occur with a C corporation when the C corporation has taxable income.

Also, I am not advising you or the company with respect to the method of federal income taxation that is best for the company and its members. Before electing how the LLC will be taxed, the company and its members should consult with their accountant or tax advisor because the election could have significant economic consequences. Facts and circumstances applicable to each new LLC will influence the taxation election that is best. An erroneous tax election may be expensive. The LLC may elect how it will be taxed by filing IRS Form 8832, Entity Classification Election, which you may download off the internet at the address set forth in item 3 of Federal Tax Forms. For more information, see IRS Publication 542, Corporations, and IRS Publication 541, Partnerships, which are available on the IRS’ web site. If the company does not make a timely election by filing Form 8832, the company will be taxed under the following IRS’ default provisions:

The limited liability company will be taxed for federal income tax purposes as: (i) a partnership if it has two or more members; or (ii) a sole proprietorship if it has a single member.

A married couple who are the sole owners of their LLC as community property and who desire to have the LLC be taxed as a sole proprietorship should complete and file an IRS Form 8832 as soon as possible after forming their LLC. Indicate on the Form 8832 that the sole owners are a husband and wife who own their interest as community property (if that is actually the case) and the LLC elects to be taxed as a sole proprietorship pursuant to Internal Revenue Service Revenue Procedure 2002-69.  I suggest you send the IRS a copy of this Revenue Procedure with the Form 8832.

For a detailed discussion on the four ways an LLC can be taxed see Arizona LLC attorney and former CPA Richard C. Keyt’s article called “How are LLCs Taxed?

Section 11.6 Electing C Corporation or S Corporation Tax Status

Important Deadline for Companies that Desire to Be Taxed as an “S Corporation” under subchapter S of the Internal Revenue Code of 1986: If you want the company to be taxed as an S corporation from the date of its formation, all of the members must complete, sign and file an IRS Form 2553 with the IRS as soon as possible, but not later than: (i) two months and 15 days after the date the LLC was formed or (ii) the beginning of the first fiscal year you want S corp status if you do not want S status from day one. If the company does not file a Form 2553 within two months and 15 days after the date the LLC was formed, the company will not be taxed under subchapter S (i.e., will not be an S corporation for tax purposes) its first fiscal year. However, the company can file the Form 2553 within the first two and 15 days of the beginning of its next fiscal year and be taxed under subchapter S from the beginning of that fiscal year.

Not every company is eligible to be taxed as an C corporation under subchapter S of the Internal Revenue Code. The company is not eligible for and may not be taxed as an S corporation if any one or more of the following circumstances exists:

  • The company has more than 100 members,
  • The company has a member who is nonresident alien, or
  • The company has more than one class of membership interests.

See your tax advisor for more information about the restrictions on ownership of companies that are taxed under subchapter S and for assistance in preparing and filing the IRS Form 2553.

Note: Do not file an IRS Form 8832 (application to be taxed as a “C corporation” under subchapter C of the Internal Revenue Code) if you file an IRS Form 2553 timely.

Section 11.7 Relief for Late Filing of Form 2553 to Elect S Corp Status

The IRS allows limited liability companies to request to be taxed under subchapter S after failing to file a timely form 2553. See IRS Revenue Procedure 2007-62. The Company must file its tax return on IRS Form 1120S along with an IRS Form 2553, which eliminates the risk that Form 1120S will be rejected by the IRS while it considers accepting the late Form 2553 is pending. The Company requests relief by filing the following IRS forms with the applicable office: (i) a Form 2553, and (ii) a Form 1120S, for the first taxable year in which S corp status was intended. The IRS Form 2553 must include a statement explaining the reasonable cause the Company failed to file the Form 2553 timely.

All of the following conditions must apply before the IRS will allow the Company to elect to be taxed as an S corporation after failing to file the Form 2553 by the initial deadline:

  • The Company failed to qualify on the first day that status was desired solely because of the failure to timely file Form 2553 with the applicable IRS Center.
  • The Company has a reasonable cause for failing to file a timely Form 2553.
  • The Company has not filed a tax return for the first taxable year in which the election was intended.
  • The Company’s application for relief is filed no later than six months after the due date of the tax return, excluding extensions, for the first taxable year in which the election was intended.
  • No taxpayer whose tax liability or return would be affected by the election, including all of its members, reported inconsistently with the S corp election on a return for the year in which the election was intended.

Section 11.8 Partnership Taxation Issues

As you know, neither KEYTLaw, LLC, nor Richard Keyt is advising the company or any member with respect to any federal or state tax issues concerning the Operating Agreement, the company or its business and activities. The company and all members and managers should consult with their accountant(s) / tax advisor(s) with respect to all company and member activities (preferably in advance of taking action) that may have federal and state tax consequences, including reviewing the proposed Operating Agreement. If the company will be taxed as a partnership for federal income tax purposes, there are several events that may occur from time to time that require the company to consult with its tax advisor and perhaps make adjustments to the company’s financial books and/or members’ capital accounts. If the company is being taxed as a partnership, it should consult with its accountant / tax advisor before taking any of the following actions, and if necessary, adjust its financial books and members’ capital accounts:

  • A member contributes any real or personal property (other than cash) to the company or the company distributes any real or personal property (other than cash) to a member. A member’s capital account must be increased (or decreased) by the fair market value (and not the tax basis) of property contributed by (or distributed to) the member. In the case of a distribution on property other than cash, the capital accounts of all members must first be adjusted to reflect the manner in which the unrealized income, gain, loss, and deduction inherent in the distributed property (which was not previously reflected in the members’ capital accounts) would be allocated among the members if there were a taxable disposition of the property by the company at its fair market value on the date of distribution.
  • A member contributes a promissory note to the company or the company distributes a promissory note to a member.
  • Adding a new member, terminating a member or changing the percentage interests of any member.
  • Whenever there may be a change of fifty percent or more of the percentage interests of the company in the same fiscal year. If more than fifty percent of the percentage interests changes hands during the same fiscal year, Section 708 of the Internal Revenue Code provides that the company will terminate for federal income tax purposes, which means the company will have to file two federal income tax returns for the year and may have adverse tax consequences.

If the company will be taxed as a partnership for federal income tax purposes, it should consult frequently with its accountant / tax advisor: (i) to review the Operating Agreement to confirm that the allocations of profits, losses and distributions are correct as intended by the members and from accounting and financial perspectives, and (ii) with respect to federal income tax issues to eliminate or reduce adverse tax and economic consequences from proposed company activity.

For example, if the company will be taxed as a partnership, make sure its tax advisor advises the company with respect to: (i) whether and when the company should make an election under Section 754 of the Internal Revenue Code, and, if it does so elect, (ii) when and how to make special basis adjustments under Section 743(b) for transferee members that provides a special basis adjustment for the transferee (new) member that generally provides the transferee member with a cost basis in the member’s share of the company’s assets. If the company is taxed as a partnership, has made a Section 754 election and makes a distribution of property that gives rise to a special basis adjustment to company property under Section 734(b), the company must generally make an equivalent adjustment to the members’ capital accounts.

Section 11.9 Federal Tax Forms

  • IRS Form 8832.  File this form to cause your LLC to be taxed under Subchapter C of the Internal Revenue Code.  Only file this form if you want your Company to be taxed as a “C corporation” for federal income tax purposes.
  • IRS Form 2553 and its Instructions.  File this form to cause your LLC to be taxed under Subchapter S of the Internal Revenue Code.  Only file this form if you want your Company to be taxed as an “S corporation” for federal income tax purposes.

Section 11.10 Request for Taxpayer Identification Number: IRS Form W-9

A person who is required to file an information return with the IRS concerning transactions with the company must obtain the company’s correct taxpayer identification number (TIN). Third parties use the TIN to report income paid to the company; real estate transactions and mortgage interest paid by the company; acquisition or abandonment of secured property by the company; and cancellation of debts owed by the company.

From time to time the company may receive requests from third parties asking for the company’s TIN. You should respond to a request for the company’s TIN by completing and delivering an IRS Form W-9 to the third party. Use the W-9 only to provide the company’s correct TIN to the person requesting it (the requester) and, when applicable, to:

  • Certify that the TIN the company is giving is correct (or the company is waiting for a number to be issued),
  • Certify that the company is not subject to backup withholding, or
  • Claim exemption from backup withholding if the company is a U.S. exempt payee.

Note: If a requester gives the company a form other than Form W-9 to request the company’s TIN, use the requester’s form if it is substantially similar to the IRS Form W-9. Do not forget to sign and date the W-9.

I have found that several times a year, but mostly during January, third parties notify me that they want my company’s TIN or EIN. I made the job of responding to the requests much easier by having a completed and signed W-9 handy so I can just mail it back or email it to the requester.

See IRS Form W-9.

Note when Completing the W-9: If the company is a single-member LLC that is disregarded as an entity separate from its member, enter the member’s name on the “Name” line of the W-9. Enter the company’s name on the “Business name” line. If the company is a multi-member company that will not be taxed as a disregarded entity, enter the company’s name on the “Name” line. Check the appropriate box for the company’s federal income tax filing status (sole proprietor, corporation or partnership), then check the box for “Other” and enter “LLC” in the space provided.

Section 11.12 KEYTLaw Not Hired to Give Tax Advice

Neither Richard Keyt nor KEYTLaw have been hired to advise the company or its members or managers with respect to any federal, state or local tax matters, elections or filings. We recommend that the company, its members and managers immediately ask their accountant or tax advisor to advise them with respect to making all appropriate tax elections and to assist the company in preparing and filing forms, if necessary. The company’s accountant will advise the company, its members and managers with respect to whether the company must obtain an employer identification number (an “EIN”), an Arizona state payroll tax withholding number, a transaction privilege number, or an Arizona Department of Economic Security number.