The 4 Main Types of LLCs and How they Pay Taxes

What is an LLC or Limited Liability Company? If you set one up as a landlord, will you have to pay less or more taxes than you would as an individual? Let’s break down all the different types of LLCs and their tax implications, one by one.

LLCs are popular in real estate, as they may protect the owner from liabilities and may offer preferred tax treatment. The structure is described as a hybrid of a corporation and a partnership, as it gives the owners limited liability, while profits are taxed as the owner’s personal income.

4 Types of LLC and their Taxes

So, which LLC type should you choose? There are 4 main kinds of LLC that rental investors can go for, each with slightly different taxation rules.

You probably want to know what tax exemptions and obligations each type of LLC entails before forming one, so here’s a breakdown of the tax requirements for each kind:

The Single-Member LLC (SMLLC)

As the name suggests, the Single-Member LLC is an LLC with only one member. This is the most affordable and popular LLC formation, as it requires less paperwork and no partners. The Single-Member LLC is somewhat similar to a sole proprietorship structure, as the owner is personally responsible for company transactions, taxes, and debts.

The Single-Member LLC has pass-through tax treatment. Instead of having to pay the standard corporate tax rate, the profits within your LLC can be included as part of your income taxes, which are reported on Schedule E of your income tax return.

A Married Couple LLC

If you are a married couple that wants to start landlording rental properties together, forming a Married Couple LLC is a good way to structure your business. Basically, the Married Couple LLC has only two members, who have to be married to each other. The structure is similar to what two unmarried business partners would set up, except you have different tax options available.

Similar to SMLLC, you’ll have pass-through tax treatment. But if the LLC is formed in a community property state, you’ll have to file a partnership tax return for your LLC. It’s advisable to do additional research on community property laws, as they vary from state to state.

If you file a partnership return, the IRS will need you and your spouse to divide your streams of income, expenses, and tax credits based on percentage ownership in the LLC.

Multi-Member LLC (MMLLC)

Like an SMLLC, a multi-member LLC combines the flexibility of a partnership with the liability protection of a corporation. It’s basically a Married Couple LLC, except the members aren’t married. You can have as many members as you want in an MMLLC, and they can be individuals, LLCs, or corporations.

MMLLCs also receive pass-through tax treatment, where each member claims their percentage share of the LLC’s profits and losses on their personal tax return - you do this by attaching a completed Schedule E (Form 1040) when sending your tax return.

The Series LLC

A Series LLC is where there’s a “parent” LLC that designates debts, obligations, and rights to the “child” LLCs, which are smaller cells, called Series. These Series operate under the parent LLC with complete liability protection but are taxed separately. This means they’re considered as franchises of the parent LLC, and may make each Series liable to pay additional taxes.

Franchise taxes vary by state. For example, if you’re in California, each Series you have will incur $800 in franchise tax. But in Delaware, it doesn’t matter how many Series you have—you only have to pay the franchise tax of $300 once, and it covers them all.

The good news is that you can create a Delaware Series LLC without actually living there. And because the Series LLC is fairly new, it’s still evolving from state to state as new laws emerge governing this type of business. Some states even let you choose the taxation method applied to your Series LLC, in which case most investors will opt for pass-through.

It’s, therefore, best to do some research and seek advice from a qualified attorney before setting up a Series LLC, especially since regulations may vary depending on where you’re based.

Conclusion

When dealing with tax, your goal is to remain on the good side of the IRS. The more prepared and informed you are, the less likely you’ll get into ugly tax disputes that may leave you with wage garnishments and a large headache to deal with.

At the end of the day, deciding which LLC you should choose depends on your personal real estate goals and the tax that you’re willing to pay.

Which type of LLC do you prefer for your rental business? Why?

Image by Gustavo Firing