There are many different ways of forming a company such as a sole proprietorship, a partnership or a corporation. Each has its own advantages and disadvantages. One major benefit of a sole proprietorship or a partnership is the flexibility in tax reporting of business income and expenses. Business profits and losses are passed through to the owners/partners who are then taxed at their individual income tax rates. The biggest disadvantage of either a sole-proprietorship or a general partnership is that the owners/partners are personally liable for all business debts and claims. Corporation, on the other hand, gives the limited liability protection to its owners but does not have the tax flexibility like a sole proprietorship or a partnership.
Now there is a new and exciting way a company can be formed where the owners receive the tax advantages of a partnership and also enjoy the limited liability protection. That entity is called a Limited Liability Company or a LLC.
The difference between a LLC and a regular corporation is that a LLC is recognized by the IRS as a “pass through” tax entity. It is not subject to corporate tax like a regular corporation. The profits and losses of the entity are passed through to its owners who then pay taxes at their own individual tax rates.
A LLC can also make an election to be taxed as a corporation by “checking the box” on the tax return. The owners should seek advice from a tax specialist in regards to selecting a “pass through” entity or a “tax paying” entity. Under certain circumstances, choosing a “tax paying” entity will result in the best tax situation.