Common LLC Questions Answered
LLC tax issues remain confusing to many practitioners
Federal tax issues for limited liability companies (LLCs) can be complex. Below are common issues for taxpayers who have LLCs and the answers to those questions.
What happens when a single-member LLC brings in another member and becomes a multi-member LLC?
If the LLC has not elected to be treated as a corporation, the LLC converts from a disregarded entity to a partnership. This is an automatic change; since no election is required, the LLC does not file Form 8832, Entity Classification Election. See Treas. Reg. §301.7701-3(b)(1) and Internal Revenue Manual 3.13.2.27.1(7) (01-01-2024).
Rev. Rul. 99-5 describes the tax consequences of this change in two circumstances: a purchase of an LLC interest and a contribution to the LLC for an interest.
What happens when a multi-member LLC loses members and becomes a single-member LLC?
If the LLC has not elected to be treated as a corporation, the LLC converts from a partnership to a disregarded entity. This is an automatic change; since no election is required, the LLC does not file Form 8832, Entity Classification Election. See Treas. Reg. §301.7701-3(b)(1) and Internal Revenue Manual (IRM) 3.13.2.27.1(7) (01-01-2024).
Rev. Rul. 99-6 describes the tax consequences of this change in two circumstances: an existing owner buys all LLC interests and a third party buys all LLC interests.
If an LLC that elected S corporation treatment revokes its S corporation election, how is the LLC treated?
When an LLC elects S corporation treatment by filing Form 2553, Election by a Small Business Corporation, it actually makes two elections: an election to be taxed as a corporation, followed by an election by the corporation for S corporation status. See IRM 3.13.2.27.1(2) (01-01-2024) and Treas. Reg. §301.7701-3(c)(1)(v)(C).
The S corporation election revocation does not undo the underlying corporation election. The LLC is taxed as a C corporation unless the LLC files Form 8832 to revert the LLC back to its default classification. See IRM 3.13.2.23.15(9) (03-08-2023).
What are the income tax consequences of making a corporation election for an LLC?
For a single-member LLC, the owner of the LLC is deemed to contribute all of the assets and liabilities of the LLC to the new corporation in exchange for its stock. This will be a §351 tax-deferred exchange. See Treas. Reg. §301.7701-3(g)(1)(iv).
For a multi-member LLC, the partnership is deemed to contribute all of its assets and liabilities to the new corporation in exchange for its stock, and immediately thereafter, the partnership liquidates by distributing the stock to its partners. This will be a §351 tax-deferred exchange followed by a §731 partnership liquidation. See Treas. Reg. §301.7701-3(g)(1)(i).
What are the income tax consequences of undoing a corporation election for an LLC?
For a single-member LLC, the corporation is deemed to distribute all of its assets and liabilities to its single owner in liquidation of the corporation. See Treas. Reg. §301.7701-3(g)(1)(iii).
For a multi-member LLC, the corporation is deemed to distribute all of its assets and liabilities to its shareholders in liquidation of the corporation, and immediately thereafter, the shareholders contribute all of the distributed assets and liabilities to a newly formed partnership. The partnership contributions will be a §721 tax-deferred exchange. See Treas. Reg. §301.7701-3(g)(1)(ii).
With respect to the corporation liquidation, the shareholders may recognize gain or loss under §331, while the corporation may recognize gain or loss under §336. Form 966, Corporate Dissolution or Liquidation, is not required for a deemed liquidation under the entity classification regulations, according to the form instructions.
When does an LLC have to get an initial or new employer identification number (EIN)?
An LLC treated as a disregarded entity must use its owner’s taxpayer identification number (TIN) for federal tax purposes except for employment and excise tax purposes; therefore, the LLC must get an EIN if subject to those taxes. See Treas. Reg. §301.6109-1(h)(2)(i).
If an LLC treated as a disregarded entity is later recognized as a separate entity for federal tax purposes and it has an existing EIN, it continues to use that EIN. If the LLC does not have an EIN, it must acquire an EIN and not use the owner’s TIN. See Treas. Reg. §301.6109-1(h)(2)(ii).
Any LLC with an EIN retains that EIN if its classification changes under the entity classification regulations. See Treas. Reg. §301.6109-1(h)(1).
Share Your Thoughts!
As a paid subscriber, you can discuss this topic in the comments section. Please keep the discussion related to this edition’s topic.
Learn More About Tom
Please take a look at my Linktree to learn about the educational opportunities I offer the tax professional community.
I have observed that disregarded entities (sole prop) who file Sch C and use their EIN appear to be exempt from IRS income matching. It appears the IRS is not associating the EIN Income with the Sole Prop SSN . These Sole Prop fill out their W-9 as a disregarded entity and put down their EIN rather than their SSN.
The W-9 apparently is NOT reviewed by any taxing agency for accuracy. I would be interested in your observations.
Tom comments that the LLC should always use the owner's TIN, not its EIN, for income tax reporting. We all agree that is a true statement.
I offer that NO taxing authority sees the W-9 that our clients file. Many of them have figured out this is a way to avoid paying tax on ALL their income. Suggested Quick Fix is to require all Sole Props to send a COPY of their W-9s to the taxing authorities.