There are many reasons why LLCs can be great for business owners. For those types of businesses that have revenue and don’t need outside investors or to issue stock options (although LLC profits interests can work), LLCs are a good choice.
For a lot of startup companies, a corporation may be the right choice, especially if it will be seeking investors, plans to be acquired by a larger player in the industry at some point, or would like to have an IPO or other offering. The choice for a lot of companies especially in the high tech sector is the corporation. But if those aren’t your goals, if you have a business plan, target market, product and are ready to sell and make revenue then an LLC may be the right choice for you. Whatever industry you are in, an LLC can be a beneficial entity to use. LLCs can do complex and sophisticated things with respect to splitting profits, can have interesting classes and structures, require less paperwork than would a corporation, and are by far more flexible. (I’ve kind of beat the LLC v. Corp. horse to death earlier so will get to the point now). One of the other great advantages of the LLC form is that it can elect (i.e. choose) to be taxed as either disregarded entity (if one member then a sole proprietorship, and if multiple members than a partnership), an S-corporation or a C-corporation.
When an LLC is formed in its home state, absent an affirmative election by the owners, it will automatically be treated as a disregarded entity for federal tax purposes. If the LLC wishes to change this classification, it can file Form 8832 with the IRS and elect to be taxed as a C-corporation. If the LLC wishes to be taxed as an S-corporation it may have to file Form 8832, Form 2553 or sometimes both. Form 8832 can be filed up to 75 days after, but no more than 12 months before, the effective date (which the LLC picks) of the conversion. Once an LLC makes an election pursuant to the filing of the Form 8832 (and/or 2553), it cannot make another election for 5 years. Most states accept the federal entity classification.
If you own an LLC and will be taking a salary and benefits from the LLC, then having the LLC taxed as a corporation will allow you to pay the payroll tax, which may be less than the self-employment tax that would be owed if the LLC was treated as a disregarded entity for tax purposes. Also if you are taxed as a C-corporation, you can deduct all of the benefits the corporation provides to you, as long you provide the same benefits to other employees. The IRS’s non-discriminatory rules under IRC section 105 and PHSA Section 2716 are a bit in depth, especially with the new regulations coming out after the Affordable Care Act.
The election is no more than that, a simple choice by the LLC as to how it will be treated for tax purposes. The election will not change the way the entity is organized under its home state law. It remains an LLC for all legal purposes, the name remains the same and all contracts remain in force (provided there is no requirement in such contracts requiring the company to be taxed as a disregarded entity).
As to the tax consequences of making the election – the IRS views an election by a disregarded entity to corporation as if the LLC was assigning all of its assets to the corporation in exchange for the corporation’s shares. This is typically a tax free transaction under IRC section 351, but there are some caveats, namely if the LLC has liabilities which exceed its debts, operating losses, or other issues. The LLCs accountant will be able to let you know if this is a good idea or not. Even if you have any of those issues your LLC can still make the election, however, some taxes may be due.