All states permit single-member (one-owner) limited liability companies (SMLLCs). A domestic SMLLC, by default, is a disregarded entity for federal income tax purposes. In that case, an SMLLC owned by an individual is treated as a sole proprietorship (or owner of rental property), while an SMLLC owned by a corporation is treated as a branch or division. But an SMLLC can elect corporate classification (Regs. Sec. 301.7701-2(a)). An SMLLC that elects to be classified as a corporation can also make an S election if all the qualifications for S status are met (IRS Letter Ruling 9636007). In fact, under Regs. Sec. 301.7701-3(c) (1)(v)(C), an eligible entity that timely elects to be an S corporation is treated as having made an election to be classified as a corporation, provided that as of the effective date of the S election, the entity meets all other requirements to qualify as an S corporation.
Using disregarded SMLLCs
Individuals can form disregarded SMLLCs to obtain limited liability protection under applicable state law without altering the way they report business or rental income and expenses on their individual federal income tax returns. Individuals can also form disregarded SMLLCs to hold nonbusiness assets (such as investments). The income and expenses related to those assets are reported by the owner as if the SMLLC did not exist. A disregarded SMLLC may also be useful to a corporation that wishes to engage in a new line of business without forming a subsidiary. The LLC, unlike a corporate subsidiary, is taxed as an unincorporated branch or division of its corporate owner, thus avoiding the consolidated-return rules. Practitioners should be careful when structuring transactions using disregarded SMLLCs--for example, individuals cannot form a partnership with their wholly owned disregarded SMLLCs because the individual and the SMLLC are treated as a single person, and a partnership needs more than one partner.
Caution: An IRS Office of Chief Counsel legal advice memorandum (AM 2012-001) clarifies that state laws allowing different classes of interests in disregarded entities are irrelevant for federal tax purposes. Regardless of state law, the owner of a disregarded SMLLC may not split its interest into separate classes of interests and may not separately allocate items of income, deductions, losses, credits, and basis among those classes.
Liability for federal taxes: Practitioners should be aware that the IRS may have notification alternatives in cases involving the federal tax liability of a disregarded entity. For example, Field Service Advice memo 200114006 determined that tax assessments made in the name and...
