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Limited Liability Company

A limited liability company (LLC) is a state-law entity that provides corporate-style liability protection with flexible federal tax classification. For REG, the most important idea is that an LLC is not a tax system by itself. Its federal tax treatment depends on how it is classified.

  • Owners: Members.
  • Liability: Members generally have limited liability.
  • Federal return: Depends on tax classification.
  • Tax character: Can be disregarded, taxed as a partnership, taxed as a C corporation, or taxed as an S corporation if eligible and elected.

Default classification rules​

Single-member LLC​

A single-member LLC is generally a disregarded entity unless it elects corporate treatment. Its activity is usually reported directly by the owner, much like a sole proprietorship if the owner is an individual.

Multi-member LLC​

A multi-member LLC is generally taxed as a partnership unless it elects to be taxed as a corporation.

Check-the-box election​

An LLC can elect federal tax treatment by filing the appropriate entity classification election. If the LLC qualifies for S status, it may also elect to be taxed as an S corporation.

LLCs combine two features that owners usually want:

  • Limited liability protection similar to a corporation
  • Tax flexibility similar to a partnership or sole proprietorship

That flexibility makes LLCs common for closely held businesses, real estate ventures, and professional practices.

Exam issues to know​

Tax consequences follow the chosen classification​

For REG questions, always determine how the LLC is taxed before analyzing basis, distributions, or owner compensation.

  • If taxed as a disregarded entity, use sole proprietorship-style rules.
  • If taxed as a partnership, use partnership basis and distribution rules.
  • If taxed as a corporation, use corporate taxation rules.

Compensation of owners​

LLC members taxed as partners are generally not employees for federal income tax purposes. Payments for services may be treated as guaranteed payments rather than wages.

Self-employment tax​

An active LLC owner may be exposed to self-employment tax if the entity is taxed as a sole proprietorship or partnership. If the LLC is taxed as an S corporation, the analysis shifts to shareholder-employee compensation and payroll taxes.

Advantages and disadvantages​

TopicLLC
Liability protectionGenerally strong
Tax flexibilityVery high
Administrative burdenUsually lower than a corporation
Investor preferencesSome institutional investors prefer corporations instead
Exam complexityMust identify tax classification first

REG quick hits​

  • LLC is a legal entity form, not a standalone federal tax regime.
  • Single-member LLCs are generally disregarded by default.
  • Multi-member LLCs are generally taxed as partnerships by default.
  • LLCs may elect corporate or S corporation treatment if eligible.
  • Always analyze the LLC under the tax rules that match its classification.

Bottom line​

An LLC is often the most flexible choice for a closely held business. On the REG exam, the trap is assuming that all LLCs are taxed the same way. They are not.