4 Different Types of LLCs and the Ways They Pay Taxes
The following is meant for informational purposes and is not legal advice. For information pertaining to your specific legal situation, please be sure to consult your attorney.
There are many different types of LLCs available for real estate investors. Which one is best for you depends on a variety of circumstances, including your personal real estate goals. But one thing many investors initially overlook is that each type of LLC comes with its own tax possibilities and obligations.
Surprise, surprise—for every different kind of LLC, there are also different tax requirements! It’s important for you to know the different taxes for each kind of LLC, ideally before you even form it. The types of taxation may make a major difference depending on your circumstances, so you want to do what’s best for you. And it’s in everyone’s best interest to keep our friends at the IRS on our good sides. The more you know, the less likely you are to get into it with Uncle Sam.
We’ve been over that before. Tax disputes aren’t pretty, folks.
Let’s go over the different kinds of LLCs, along with the taxes you have to pay for each particular type of LLC.
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The Single-Member LLC
The single-member LLC is an LLC with only one member, as its name suggests. The single-member LLC will always have pass-through tax treatment. What this means is that, instead of having to pay the 39.1% corporate tax, you can include the profits of your LLC on your income taxes. Specifically, the profits and losses from the real estate within the LLC will be reported on Schedule E of your income tax return.
A Married Couple LLC
A married couple LLC is an LLC whose only members are two people who are married to each other. Like the single-member LLC, a married couple LLC will usually have pass-through tax treatment. There is one huge exception: This isn’t the case if the LLC is formed in a community property state. Do your homework on this if taxation is a major motivation for forming this type of entity.
Related: How to Grow Your Wealth With an IRA-Owned LLC
If your LLC is formed in a community property state, you will have to file a partnership tax return for your LLC. As of 2018, the following states have community property laws: Louisiana, Arizona, California, Texas, Washington, Idaho, Nevada, New Mexico, and Wisconsin.
If you file a partnership return, you and your spouse will each have to include your respective shares of the profits on your income taxes. This is the main area you’ll have to keep really clean, so you may have to do what some couples find difficult even after decades of marriage: Actively communicate with your partner. Use your words, and listen actively to what the other person has to say before responding. Empathize with their concerns, and address potential points of contention logically. While I’m not your lawyer based on this article and therefore can’t dispense direct legal advice, I’d just go ahead and recommend this as good general life advice.
If your LLC has two members that aren’t married, then it’s considered a multi-member LLC. A multi-member LLC also receives pass-through tax treatment. Each member will claim his or her share of the LLC’s profits on their tax return. As an added bonus, a multi-member traditional LLC is more difficult to pierce in court.
Previous commenters on my articles and in the BiggerPockets forum often ask about ways to prevent your LLC from being perceived as an “alter-ego” of you. A multi-member LLC formed with someone you trust is one maneuver you can make to prevent this possibility.
The Series LLC
If you’ve read my blog postings before, you may already know a bit about the series LLC and its many awesome uses. The series LLC uses a parent-child structure, which allows you to create as many “series” as you want. These series operate directly under your parent LLC, but are treated separately for liability purposes. They work exactly like miniature LLCs, complete with liability protection. Think of the parent LLC as “Big Daddy,” with each series as a different child. Big Daddy can have as many babies as he wants, without waiting nine months like us mere mortals have to. But when it comes to paying taxes with an (S)LLC, things can get tricky.
For example, in California, each series in a series LLC will have to pay an $800 franchise tax. For this reason, I often recommend that California-based investors check out the Delaware Statutory Trust (DST). It offers the same benefits as the series LLC and no obligation to pay the franchise tax. Why? Simply put, the DST is a type of trust. Trusts are viewed as estate planning tools, and the strict laws in California that apply the franchise tax to LLCs do not apply to the DST.
But in Delaware, no matter how many series you have in your series LLC, you’d only pay the $300 franchise tax one time. Texas series LLCs must still file annually, but are actually not responsible for any annual corporate taxes. Investors who use a Texas series LLC simply file “no taxes due” with the state comptroller annually.
And now for the good news: You can create a Delaware series LLC or a Texas series LLC without actually living in either state. You are not always bound by your geography. This is where your ability to do a little bit of research, combined with your willingness to ask for help from a qualified attorney, can really save you a lot in the long-run.
Related: The Traditional LLC vs. the Series LLC: Which is Better for Real Estate Investors?
Because the series LLC is fairly new, most states allow you to choose the way it gets taxed. Most investors opt for pass-through taxation, but your circumstances will help decide which choice is best for you. That said, as new laws get passed, this may or may not change from state to state. Just consider that another big reason to get help from a professional.
Bottom Line: Seek Professional Help Before Forming Your Real Estate LLC
A qualified attorney and CPA can be your biggest assets when deciding which type of LLC to form. When vetting your professionals, consider seeking out pros who are also investors themselves. Such professionals are able to view your situation through two lenses: their professional judgment and experience and their experience as fellow real estate investors.
I hope this information has been helpful to you. If you have any questions about the tax treatment of LLCs, (S)LLCs, or other entities, feel free to fire away in the comments below. I do this for a living, but am always happy to help answer questions that help other investors understand the tools that help us become and stay successful. Even if they involve taxes.
Leave them below!
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Scott Smith helps clients nationally and internationally from his office in Austin, Texas. With over 5 years experience in the litigation, Scott works on proactively building defense in anticipation of future lawsuits for real estate investors. Scott is one of the few attorneys in the nation that structures companies for maximum protection with minimum taxes.
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