A married couple forming an LLC is entitled to select the federal tax method applied to the business. Choosing carefully is important because each alternative has a distinct impact on the amount of taxes owed who is responsible for paying it. Tax consequences for an LLC are often like a partnership, but LLC members may also choose between two corporation tax styles. When the managing members are a husband and wife, they have an additional tax option.
The federal government typically allows an LLC with more than one member to be classified as either a partnership or a corporation. Any business with multiple owners obtains an identification number from the Internal Revenue Service. A default tax classification of partnership is assigned when obtaining an employer identification number for an LLC with multiple members. Partnerships file tax returns but pay no income tax. Owners owe tax on their shares of income. So, a husband and wife as joint owners are each allocated separate portions of income.
An LLC taxed as a regular “C corporation” files a specific tax return and owes tax on the income. Corporations compensate their working owners with wages just like other employees. Corporations also pay dividends to the business owners. These payments are not tax-deductible expenses of the company. Therefore, owners of an LLC taxed as a regular C corporation incur double taxation. First, business profit is taxed as corporate income and then the dividends paid to the individual owners are taxed as individual income.
When an LLC selects federal tax status as an “S corporation” the income is reported on a tax return for the business but passed through to the owners for assessment of tax. Owners report their shares of income like an LLC taxed as a partnership. However, unlike a partnership, S corporation profit does not incur an extra tax as self-employment income. Distributions of S corporation profit also escape tax as dividends like distributions from C corporations. Reasonable compensation to owners is required before any profit distributions. Employment taxes are assessed on these wages.
A special rule applies to an LLC not taxed as a corporation that is a partnership of a married couple. Instead of a separate tax return for the LLC as a partnership, a husband and wife may divide each item of income, expense and tax credit. This division is proportional to their percentages of ownership in the LLC. Spouses therefore account for respective shares of LLC income as if two separate businesses existed. Each spouse is credited with self-employment earnings that apply to calculation of tax and future benefits for Social Security purposes.
- Internal Revenue Service: Limited Liability Company
- Internal Revenue Service: LLC Filing as a Corporation or Partnership
- Internal Revenue Service: Instructions for Form 1120
- Internal Revenue Service: S Corporations
- Internal Revenue Service: S Corporation Compensation
- Internal Revenue Service: Husband and Wife Business