In 1997, the Internal Revenue Code passed regulations called the "Check the Box" rules which opened the floodgate for new limited liability company formations. These rules took away very complicated and uncertain regulations for how a limited liability company would be taxed for federal income tax purposes and basically said, "Let each limited liability company decide for itself how it wants to be taxed."
LIMITED LIABILITY COMPANY CAN BE TAXED AS A CORPORATION IF IT DESIRES
Bfore 1997, one of the biggest reasons for choosing a corporation over a limited liability company WAS taxation. Some businesses were better off being taxed as a C corporation or an S corporation under the IRS rules. Well now- a limited liability company can choose to be taxed as a C corporation or an S corporation (assuming it meets the S corporation rules) for tax purposes and still get all the advantages of an LLC (limited liability company) under state LLC laws.
This is the best of both worlds and,in essence, takes away most of the reasons why any small business would ever choose a corporation entity over an LLC entity. There are no requirements for an LLC to meet if it desires C corporation taxation as long as it makes certain filings in a timely fashion. If an LLC wants to be taxed as an S corporation, it must meet the same requirements that a corporation must meet to be eligible for S corporation taxation under the IRS laws.
Still today, in practice, many new businesses receive advice from their tax advisers that they should form a corporation instead of a limited liability company and then elect for the corporation to be an S corporation. Accountants especially will recommend the corporation with the S corporation tax status because this is what they have worked under for years before the LLC was able to achieve this same tax status. They are just used to the older way- but the older way may not be the best for you given the new options. This advice is usually given because the accountant or adviser is not up to date on the limited liability company as the better and more flexible choice.
A limited liability company imposes much less formalities on owners and provides a more flexible business entity for the small business. Plus, the limited liability can elect to be taxed as an S corporation- so you get the best of both worlds.
I would definitely defer to your specific accountant or adviser in this decision as he or she should know a lot more about your business in order to arrive at the best advice for you. However, if he or she advises to form a corporation for a small simple business, I would just make sure that he knows that a limited liability company (LLC) can be taxed as an S corporation and find out another reason why he is advocating the corporation.
DEFAULT TAXATION FOR A LIMITED LIABILITY COMPANY
Single Member LLC. If a limited liability company is a single member LLC, the default tax classification is that the IRS will be a "disregarded entity" for tax purposes. This means that the single member will report all LLC business income on his or her own personal tax return. It is the simplest method of taxation. Remember, the entity is only disregarded for TAX purposes not other purposes such as limited liability and governance.
If the single member LLC wants to be taxed as a C corporation or an S corporation (it must meet the S corporation requirements,) the single member LLC can do so by filing a certain election form with the Internal Revenue Service. This election form must contain certain required information and must be filed within 75 days from the formation of the single member LLC in order to be taxed as a C or S corporation from its formation date.
Multi-Member LLC. If a limited liability company has more than one member, the default tax classification is that the IRS taxes the LLC as a "partnership" under the IRS laws. This is a single layer of taxation and the tax profits or losses flow through to each member and are eventually reported on their personal returns in a Schedule. The LLC itself also has to file an informational return with the IRS.
A multi-member LLC can choose to be taxes as a C corporation or an S corporation (it must meet the S corporation requirements) if it makes sense for the business. Similar to above, an election form must be properly and timely filed with the IRS.
COMMON CHOICE FOR THE SMALL BUSINESS LIMITED LIABILITY COMPANY
The default tax classifications are what they are for a reason. The great majority of small business limited liability companies prefer the single layer of taxation afforded by the disregarded entity taxation for a single member LLC or the partnership taxation for the multi-member LLC. However, there are certain instances where corporation taxation may be more beneficial for your limited liability company especially in the area of employee benefits if you have or are planning on having a decent size employment staff or desiring to offer premium benefits to your employees (which may include yourself).
Speak to your tax adviser for the best tax classification for your limited liability company.