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Create Your LLC Operating Agreement Checklist

1. Decide a name for your LLC
2. Principal Office
3. Registered Agent/Office
4. Initial members
5. Decide the ownership interests of each member
6. Decide the amount of capital each member will contribute.
7. Will any members be granted an interest solely for the performance of services?

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LLC Tax Treatment
An LLC’s income passes through to its members, who report the income on their personal income tax returns. For tax purposes, a single member LLC is treated as a sole proprietorship, and a multi-member LLC is treated as a partnership.
The LLC itself does not ordinarily pay federal income taxes on its own behalf as a separate entity (some states impose taxes on LLCs as a separate entity). However, an LLC is required to file an annual informational tax return with the Internal Revenue Service.
It is possible for an LLC to elect to be taxed in the same manner as a “C” corporation (double taxation), but this is generally not advisable, as this election will last for a minimum of five (5) years and as there may be tax consequences for switching back to pass-through taxation.
LLC Tax Return Filings

Single Member LLCs

Generally, when a limited liability company (“LLC”) has only one member, the fact that it is an LLC is ignored or “disregarded” for the purpose of filing a federal tax return. Remember, this is only a mechanism for tax purposes. It doesn’t change the fact that the business is legally a Limited Liability Company.

If the only member of the LLC is an individual, the LLC income and expenses are reported on Form 1040, Schedule C, E, or F.

If the only member of the LLC is a corporation, the LLC income and expenses are reported on the corporation’s return, usually Form 1120 or Form 1120S. If you prefer to file as a corporation instead of as a “disregarded entity” Form 8832 must be submitted. Otherwise, you are not required to file Form 8832.

Single-member LLCs may not file a partnership return.

Multiple Member LLCs

Most LLCs with more than one member file a partnership return - Form 1065. If you would rather file as a corporation, Form 8832 must be submitted
Self-employment Taxes

An LLC member is subject to self-employment taxes (the current self-employment tax rate is 15.3%) on his/her share of LLC profits, if any, one of the following conditions apply:

• He/she works more than 501 hours for the LLC during the LLC’s tax year (members who do not play a role in the management of the LLC or who are not employed by the LLC, but simply receive a share of the profits by virtue of their ownership interest, may be exempt from paying self-employment taxes);
• The LLC offers professional services in the areas of consulting, health, law, engineering, architecture, accounting, or actuarial science;
• He/she is allowed to execute contracts for the LLC.

In most cases, members will be required to make quarterly payments of their estimated tax liability to both the state and to the federal government.
In some cases, classification as a self-employed taxpayer is preferable to being treated as an employee. For example, deductions for business expenses of self-employed workers are above-the-line deductions under Internal Revenue Code Section 62(a)(1) and reduce the taxpayer’s adjusted gross income. Most employee business expenses are itemized deductions, and are also “miscellaneous itemized deductions”. Taxpayers can deduct miscellaneous itemized deductions only to the extent that the total amount of those deductions exceeds 2% of adjusted gross income. For most taxpayers, this means that miscellaneous itemized deductions cannot be deducted at all.

One of the major benefits of being considered self-employed arises when a taxpayer has to pay for premiums for health insurance. Self-employed taxpayers can fully deduct the cost of health insurance. On the other hand, employees can only deduct the cost of premiums that they pay only to the extent that the premiums exceed 7.5% of their adjusted gross income.

Contributing Capital to the LLC

In general, no gain or loss is recognized upon the contribution of money or property to a limited liability company (“LLC”) in exchange for an LLC interest. Neither the contributing member nor the LLC is taxed.

The contributor will receive a basis (the basis play a very important role in accounting for taxable gains) in the cash or property contributed equal to the amount of cash contributed and the basis of the property contributed (including any liabilities associated with the property). In other words, the basis the contributor had in the property contributed becomes the LLC’s basis in the property and the contributor’s basis in the LLC interest granted. Whereas, the contributor’s capital account (the capital account represents the equity that member has in the LLC) will equal the amount of cash contributed and the fair market value of the property contributed to the LLC (net of liabilities). If a member is providing services to the LLC, the value of the services provided does not constitute a contribution of property for tax purposes.

For example: Steve contributes a building to the LLC. The building has a fair market value of $10,000, with a basis to Steve of $6,000. Steve receives a 10% interest in the LLC in exchange for contributing the building. Steve has no gain on the contribution: his basis in his LLC interest is $6,000, and the LLC’s basis in the building is $6,000 (a “carryover basis”). However, Steve’s capital account in the LLC is $10,000 (the fair market value of the building on the date of contribution). Alternatively, if Steve contributed $1,000 in cash to the LLC, Steve’s basis in the LLC Interest he received and his capital account would be $1000.

The Computation of LLC Profits or Losses

A limited liability company (“LLC”) shall not be subject to federal income tax. Persons carrying on their business as members shall be liable for income tax only in their separate or individual capacities.

Computing the LLC’s amount of profits or losses is important in determining how much profits or losses should flow through to the members. Once the LLC’s amount of profits or losses has been determined, the profits or losses can then be allocated proportionally to the members according to the allocation determined by the LLC’s Operating Agreement.
In general, LLC taxable income is computed in the same manner as an individual’s taxable income with certain modifications. The most important modification is that items described in Internal Revenue Code Section 702(a) are separately stated. The reason for separately stating these items is that they have special significance to individual members. Internal Revenue Code Section 703(a) also denies two types of deductions that individuals are normally permitted. The first type of deductions are those that are considered inappropriate for LLCs, such as the deduction for personal exemptions and the itemized deductions. The second type are those deductions which the benefits are passed through to the members in their individual capacities, such as certain foreign taxes, charitable contributions, net operating losses, and depletion and of oil and gas wells.

The taxation of LLCs is based on a blend of entity and aggregate notions of partnership taxation. There are some items that will affect all members the same way, without regard to the members’ tax profits. For example, consider ABC, LLC whose only tax item is for the year is a $10,000 capital gain, which is allocated equally between its two members, Steve and Jane. If Steve has no other capital gains or losses for the year, and Jane has a $2,000 capital loss for the year, the tax effect of the $5,000 LLC capital gain allocated to each member would be different. Steve would report a $5,000 net capital gain, while Jane would report a $3,000 net capital gain. If the LLC gain was expressed simply as net $4,000 income for the year, without specifying its character as capital, the members would not have the information necessary to adequately report their income for the year. Thus, the LLC information return must separately state this capital gain, as well as other items that can affect the members in different manners.

The Tax Treatment of an LLC Distribution

Generally, the LLC and its members do not recognize gain or loss on a distribution of cash or property. Gain or loss would only be recognized when deferral is impractical or when it would result in a change of character.

Internal Revenue Code Section 731 provides for nonrecognition of gain or loss to all parties when LLC property or money is distributed. In the case of a cash distribution, the distributee simply reduces his/her outside basis by the amount of money received, preserving any inherent gain or loss in his/her LLC interest. A member’s initial outside basis equals the amount of cash the member contributes to the LLC, the basis the member had in any property contributed, and the member’s share of the LLC’s debt. In the case of a property distribution, the distributee’s outside basis is allocated among both the property or properties received and his/her continuing interest in the LLC (if any). Any pre-distribution inherent gain or loss in the distributee’s LLC interest is preserved either in the property received or in his/her continuing interest in the LLC. Gain or loss is recognized only when deferral is impractical or would change the character of income or loss.

Recognition of Gain

Distributions generally trigger a gain if a member receives a distribution of money in excess of his/her outside basis or when an LLC with “hot assets” makes a non-pro rata distribution. In general, “hot assets” are defined as unrealized receivables or inventory of the LLC. However, when an LLC distributes property to a member, the inherent gain or loss in the member’s interest can be preserved by adjusting the basis of the distributed property.

Recognition of Loss

A member recognizes a loss only in a liquidating distribution, and then only under certain circumstances. A loss is never recognized in a current (non-liquidating) distribution. In a situation where a liquidating distribution consists only of cash, unrealized receivables and inventory, the distributee will recognize a capital loss if his/her outside basis exceeds the sum of money distributed plus the basis he/she takes in the distributed property. This is because, in this situation, the distributee receives no capital asset in which to defer the loss.


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