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
EIN?
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
instructions that