TEXAS LIMITED LIABILITY COMPANY TAX STRUCTURES

Single Member LLC – Disregarded Entity

Scenario 1 –

Tex. Business Organizations Code Default.

Sec. 101.201. Allocation of Profits and Losses. The profits and losses of a limited liability company shall be allocated to each member of the company on the basis of the agreed value of the contributions made by each member, as stated in the company’s records required under Section 101.501.

Sec. 101.203. Sharing of Distributions. Distributions of cash and other assets of a limited liability company shall be made to each member of the company according to the agreed value of the member’s contribution to the company as stated in the company’s records required under Sections 3.151 and 101.501.

A membership interest in a limited liability company may be community property [Tex. Bus. Orgs. Code § 101.106(a-1)], but a member’s right to participate in the management and conduct of the company’s business is not community property [Tex. Bus. Orgs. Code § 101.106(a-2)]. On a member’s divorce, the member’s spouse, to the extent of the spouse’s membership interest, if any, is an assignee of the membership interest [Tex. Bus. Orgs. Code § 101.1115(a)(1)]. On a member’s death, the member’s surviving spouse, if any, and an heir, or a devisee, personal representative, or other successor of the member, to the extent of their respective membership interest, are assignees of the membership interest [Tex. Bus. Orgs. Code § 101.1115(a)(2)]. On the death of a member’s spouse, an heir, or a devisee, personal representative, or other successor of the spouse, to the extent of their respective membership interest, if any, is an assignee of the membership interest [Tex. Bus. Orgs. Code § 101.1115(a)(3)]. These provisions do not impair an agreement for the purchase or sale of a membership interest at any time, including on the death or divorce of an owner of the interest [Tex. Bus. Orgs. Code § 101.1115(b)].

Spouses can elect whether to file tax returns for the LLC through the earning spouse or as a marital partnership by adding the spouse as an owner.

BEWARE!!A change in the reporting position between spouses will be treated for federal tax purposes as a conversion of the entity!! This means that if spouses file the LLC’s return as joint earnings, even if the entity hasn’t formally converted to a partnership, the IRS will consider the LLC to have multiple owners, and to be taxed as a partnership, regardless of Texas law.

Single Member LLC – Regarded Entity

Scenario 2 –

8832 Election for Corporate Treatment.

The LLC is able to file a tax return separate from its owner, which can be advantageous when the corporate tax rate is lower than the individual tax rate.

OR

The LLC can also elect S corporation status after electing for corporate taxation – which means that the LLC files its deductions and the individual owner of the LLC individually reports distributions.

With an entity taxed as an S corporation, only the wages paid to its owner/employees are earned income subject to FICA tax for Social Security and Medicare. Other net earnings that pass through to the owners are considered dividend income. This means those payments are not subject to SECA tax — provided the owner materially participates in the business — and they are not considered passive income.

Multiple Member LLC

Scenario 1 –

Default Partnership.

Specifically, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation.

Scenario 1A –

Default Partnership with contribution accounting.

When an LLC utilizes the statutory default provisions for accounting of contributions, this means that the ownership of the LLC is calculated according to the contributions made to the LLC. So, if Bob gave $10,000 and Becky gave $100,000, then Bob owns 11% of the LLC, and Becky owns 89%. This percentage is applied to the member capital accounts for the purposes of allocations of losses and profits, distributions, and voting rights.

The percentage must be recalculated and changed every time there is an additional authorized contribution by a member or members.

Scenario 1B –

Default Partnership with company agreement.

The members of an LLC can vote to approve a company agreement, and the agreement can include provisions establishing that the Members all account for losses and profits, and distributions, according to an established percentage of ownership. Example: Bob contributed nothing to the company but he has a 25% interest.

When the company agreement establishes a pre-calculated percentage of ownership, each relevant owner must report any income realized as a result. Example: Bob contributed his services, and as result he now has a 25% interest. Bob must report 25% of the value of the company as earned income.

The LLC can also issue and record “units” to its owners. I.e., instead of saying Bob has a 25% interest, the company will say Bob owns 250 units out of 1000 units issued. The law also allows the LLC to refer to its units as “shares”.

Scenario 1C –

Default partnership with company agreement. 

An LLC is authorized by its company agreement to admit members to the LLC without the member owning any interest in the LLC.

This means that certain persons or entities can be appointed as a Member for governance purposes, to take place in voting, and for statutory rights. These Members are not required to account for the LLC’s income – although the LLC may choose to compensate them for their service as a managing member.

Scenario 2A –

Corporate Tax Election.

Specifically, a domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Form 8832 and affirmatively elects to be treated as a corporation.

Scenario 2B –

Corporate Tax Election for S Corp.

In order to become an S corporation, the partnership taxed as a corporation must submit Form 2553, Election by a Small Business Corporation signed by all the shareholders.