LLC Reporting as an S Corp

[John of PA]

An LLC can choose how it want's to report it's tax return (check the box rules). I have a new client, a single member LLC, whos previous accountant filed the taxes as an S Corp. Would I need permission from IRS to change this "check the box" decision and start filing this business as a 1040 Sch C?

[rosieea]

An LLC can choose how it want's to report it's tax return (check the box rules). I have a new client, a single member LLC, whos previous accountant filed the taxes as an S Corp. Would I need permission from IRS to change this "check the box" decision and start filing this business as a 1040 Sch C?

The election is generally locked in for 5 years. However, see TTB pg 18-14 for exceptions which may apply.

[Roland Slugg]

Changing classifications

The election is generally locked in for 5 years.

As I understand it the 5-year rule only applies if an entity wants to change its classification again after already changing it once. John, please see F-8832 and its instructions.

It seems to me that changing the classification from corp to non-corp would constitute a de-facto dissolution of the corp. Anybody have experience with this?

[Bees Knees]

Changing from an entity taxed as a corporation to an LLC taxed as a partnership or a sole proprietorship is a taxable liquidation of a corporation and a re-contribution of its assets to a newly organized LLC.

[John of PA]

Always an LLC

The Corp has not changed structure. It is and was always an LLC. It is changing from an LLC electiing to file on a 1120S, to an LLC electing to file on a Sch C. Thanks for your tips on the 5 year rule, I'll check it out.

[Bees Knees]

An LLC electing to be taxed as an S corporation for federal tax purposes is an S corporation for federal tax purposes. Therefore, it is an S corporation liquidation for federal tax purposes when it decides it doesn't want to be an S corporation for federal tax purposes anymore.

[John of PA]

Hard to Believe

I find that Hard to Believe; anyone else want to jump in. You may be right BeesKness becasue I'am not sure myself; but how can an entity that is not a corporation go through a corporate liquidation; there are no asset sales or money's disbursed; they are simply moving thier P&L reporting from an 1120S page 1, to a Sch C.

[Bees Knees]

Reg. Sec. 301.7701-1(a)(1), “…Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.”

Reg. Sec. 301.7701-3(a), “…A business entity that is not classified as a corporation…can elect its classification for federal tax purposes as provided in this section.”

Reg. Sec. 301.7701-3(c)(1)(v)(C), “…An eligible entity that timely elects to be an S corporation…is treated as having made an election under this section to be classified as an association…"

Reg. Sec. 301.7701-3(g)(1)(ii), “…If an eligible entity classified as an association elects…to be classified as a partnership, the following is deemed to occur: The association distributes all of its assets and liabilities to its shareholders in liquidation of the association, and immediately thereafter, the shareholders contribute all of the distributed assets and liabilities to a newly formed partnership.”

Reg. Sec. 301.7701-3(g)(1)(iii), "...If an eligible entity classified as an association elects...to be disregarded as an entity separate from its owner, the following is deemed to occur: The association distributes all of its assets and liabilities to its single owner in liquidation of the association."

There you have it. You don’t have to actually be incorporated under state law for the corporate liquidation rules to apply. The regulations that allow you to elect to be taxed as a corporation have consequences, if you ever decide to elect back out of corporation tax treatment.

[veritas]

I gotta go with the Bees.

[rosieea]

As I understand it the 5-year rule only applies if an entity wants to change its classification again after already changing it once.

The very first filing of form 8832 constitutes an election to change classification. That is, it is an election to be taxed as something other than its default classification. The 5-year rule does not apply if the election is effective on the date of the entity's formation. Otherwise, the rule generally applies.

[OldJack]

I agree with Bees... you have to go thru a corp liquidation which is why I discourage an LLC electing S-corp status just to save on SE tax. In reality there is no such thing as an LLC for federal tax purposes as that designation is only a state entity. The LLC entity is a S-corp entity that must be liquidated. Just because your client doesn't keep balance sheet records does not mean that assets, liabilities, and equity accounts do not exist. A review of old depreciation schedule may actually show assets that were deducted under §179. There may be no asset sales or money disbursed but a liquidation must be done as the shares of stock are actually redeemed for fair market value on liquidation, thus resulting in a tax reportable event on shareholders 1040.

[John of PA]

Shares of Stock

I agree with Bees... you have to go thru a corp liquidation which is why I discourage an LLC electing S-corp status just to save on SE tax. In reality there is no such thing as an LLC for federal tax purposes as that designation is only a state entity. The LLC entity is a S-corp entity that must be liquidated. Just because your client doesn't keep balance sheet records does not mean that assets, liabilities, and equity accounts do not exist. A review of old depreciation schedule may actually show assets that were deducted under §179. There may be no asset sales or money disbursed but a liquidation must be done as the shares of stock are actually redeemed for fair market value on liquidation, thus resulting in a tax reportable event on shareholders 1040.

But there is no shares of stock, there is no corporation. The entity is an LLC. I can understand if certain tax attributes must be recognized as if a corporation were liquidated. Perhaps this is really what is being said here.

[Bees Knees]

But there is no shares of stock, there is no corporation. The entity is an LLC. I can understand if certain tax attributes must be recognized as if a corporation were liquidated. Perhaps this is really what is being said here.

It is a matter of semantics. You are correct, there are no shares of stock under state law. But the regulations refer to shares of stock under the election to be taxed as a corporation. Since there really are no shares of stock, the regulations are using the term in a general ownership sense. They use the term "deemed." There is "deemed" to be shares of stock, even though they don't actually exist under state law.

[OldJack]

ownership

An LLC has membership unit shares and should actually issue membership certificates which are in essence shares of stock when the LLC has elected S-corp status. A partnership should have units of ownership certificates which are in essence much the same as shares of stock or if you like "proof of ownership". We professionals should insist that our clients issue ownership certificates. If two partners end in a lawsuit they need to be able to prove their ownership in court with a partnership agreement and or ownership certificates. When was the last time you ask your S-corp client if they had stock certificates issued? You may find, like I have, that your small business client has never seen a "certificate" as he thinks he is the corporation and after all it says he owns so many shares on the articles of incorporation or form 2553.

[John of PA]

Thank You

Thank you for all the input. I did indeed learn something in this exchnge. Phamtom stock, deemed liquidations, sounds like we now may have a new buzzword "virtual taxation".