LLC, Corporation and Partnership–legal and tax classifications

October 27, 2017 - Posted by: admin - In category:

taxes - No Responses

I was reading an excellent article this morning about why it usually is a bad idea to own rental properties in an S-Corporation.  The article is well-written in most respects and does a good job walking through basic legal, accounting and tax planning situations.  The general premise is sound–namely, that because of the application of tax rules, getting real estate out of an S-Corp will almost always be an expensive proposition that results in a tax high tax bill for the owner of that company.  So far, so good.

However, towards the end of the article, the author, who is a CPA, makes a common mistake in her recommendation that the solution to the S-Corporation problem distributing the real estate to its owner is to use an LLC.  In other words, according to the writer of the article, using an LLC will solve the problem of the S-Corporation.  Is that true? No way to know if it is true from those statements alone, as the author of this article has made a prevalent mistake.  She has used legal and tax classifications interchangeably when they are not interchangeable, at least not in this manner.

You see, an LLC can elect to be taxed as an S-Corporation, and this is true whether we are dealing with a single-member LLC or a multi-member LLC.  An LLC can also choose to be taxed as a disregarded entity (single member LLC) or as a partnership (multi-member).  So in this context, when we are dealing with the critical point of how an entity is taxed (i.e., how it is viewed in the eyes of the IRS), saying that it is an LLC does not give us the information we need to know.

As an attorney, when I deal with an LLC, a Corporation or a Partnership, most often I am focusing on the legal aspects of such entities.  This is true if I am asked to assist with the formation of one or more such legal entities (each a creature of applicable state law).  Such is also the case when I am often contacted to advise on the legal standing of business entities previously formed by someone else and which are the basis for existing business operations.  In short, just as an accountant sees and considers certain things when he or she is looking at an LLC or a Corporation, an attorney (because of different training and expertise) will usually have a different focus when dealing with such matters.  For me, an LLC is most often used for liability protection–it is designed to be a legal liability firewall for the owner(s) of a business.  While I am aware of the options an LLC has for how it will elect to be taxed (as noted above), such accounting and tax matters are beyond the scope of my duties in almost all circumstances.  I always recommend that my clients work with a good accountant and I, therefore, defer such tax and accounting matters to such accountants.

Please remember that first and foremost, an LLC is a legal structure.  The limited liability company was designed, as the name indicates, to serve as a vehicle for owning a business enterprise in a manner which limits legal liability exposure to the owner or owners.  Saying that a business is an LLC does not answer the question about how it is taxed.  

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