Volume 18 Issue 4 -- July/August 2006
The Limited Liability Company (LLC) is a relatively new form of business
entity created by statute by the individual states.
Congress, however, did not create a new tax classification for the LLC.
Instead, the IRS uses the tax entity classifications that have always
been used for business taxpayers: corporation, partnership or sole proprietor.
An LLC can elect to be classified as a corporation by filing a Form 8832,
“Entity Classification Election.” By default, however, a single-member LLC
will be classified by the IRS as a “Disregarded Entity” and treated as a
sole proprietorship for income taxes. All
income and expenses of a sole proprietorship are reported on Schedule C on the
owner’s income tax return (Form 1040).
Under the current rules, as explained in IRS Publication 15-A, disregarded
entities may pay employment taxes either:
using the owner’s name and Social Security Number (SSN), whereby the owner
is considered to be the employer; OR
using the entity’s name and EIN (Employer Identification Number) whereby
the entity is considered to be the employer.
Principals of one-member LLC’s are faced with the decision of whether to
obtain an EIN for the LLC or to use the member’s SSN for filing employment tax
returns and related reporting. While this may seem like a simple decision, in
actuality it may be confusing. Consider this scenario:
Joe is a professional snake charmer with a growing list of clients.
For various reasons, Joe decided to create a formal entity for his
business. He organized a new LLC
called “Joe’s LLC.” Joe is the
only member of the LLC and he has one employee. Should Joe’s LLC apply for an
Ignoring tax considerations for a moment, one of the reasons many
individuals establish single-member LLC’s is for liability protection. Placing
a business or an asset, such as rental real estate, in an LLC can protect the
owner from some liability risks associated with the business or asset. Keeping
the LLC’s assets and finances separate from the owner’s is important, and
having a separate bank account is a good way to start. Getting a bank account,
however, requires using an SSN or EIN. Joe’s goal of protecting his personal
assets from his business risks would be furthered if he obtained a separate EIN
for the LLC so that it could open a bank account in the LLC’s name, under its
own tax ID number, rather than under Joe’s SSN.
The tax situation is less clear. Unless Joe elects otherwise, “Joe’s
LLC” is a “disregarded entity.” As
such, Joe’s LLC will report its income on Joe’s personal tax return, Form
1040 using Joe’s SSN. Joe,
however, wants to obtain an EIN, a separate identification number for the LLC,
because, after all, one of the reasons Joe organized the LLC was for the
personal liability protection the entity gave him in case a client is bitten by
a snake. As further evidence that
the assets of the LLC are separate from his personal assets, Joe wants to open a
separate bank account for the LLC using a separate EIN rather than his SSN.
Joe realizes that he will have to be careful not to use his SSN
and EIN interchangeably.
Joe obtains a Form SS-4, “Application For Employer Identification
Number.” He reads in the
A single-member domestic LLC that accepts the default classification [of disregarded entity] does not need an EIN and generally should use the name and EIN of its owner for all federal tax purposes. However, the reporting and payment of employment taxes for employees of the LLC may be made using the name and EIN of either the owner or the LLC.
The instructions do not make clear that the IRS considers an individual’s
SSN also to be an EIN. And, the IRS implies that Joe should not
obtain an EIN and should use his SSN for all purposes.
As it turns out, if Joe has employees he may not have to ponder the choice
of EIN versus no EIN for too long. On
October 18, 2005, the IRS published proposed Regulations 114371-05,
“Disregarded Entities; Employment and Excise Taxes.” 70 Federal Register
60,475 (October 18, 2005). Under
these proposed Regulations, disregarded entities will be treated as separate
entities from their owners for employment tax and related reporting and,
possibly, certain excise taxes. If
these Regulations are adopted, one-member LLC’s with employees will no longer
have the option of using the owner’s SSN for employment tax purposes.
It would be mandatory to obtain EIN’s for such purposes.
If these proposed Regulations are finalized by the end of 2006, they could become effective no earlier than January 1, 2007. If they are not finalized by the end of 2006, then the earliest they could become effective would be January, 2008. It is also possible that the IRS will not finalize the current proposals or will change them significantly before they are finally adopted, so stay tuned. . . .
2007, the IRS adopted as final the regulations discussed above
effectively requiring an EIN for single member LLCs that have
By Tax and Business Professionals, Inc.
9837 Business Way
Manassas, VA 20110
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.