How is an LLC Taxed?

Full Question:

In 2004 I started a design company. In 2005, I brought in a partner and re-filed the company as an LLC. He stayed at his job, while i worked alone for the first year. My wages - as paid by the company were $13000 which taxes were paid upon. The 23000 we had in profit, went into the company account as business collateral for equipment and the potential wages for my partner when he would quit his job and join the following year. It was my understanding that taxes were only paid on distributions and that if the money was not paid to either partner, it would not be taxed as it was business collateral. in 2006, my partner began withdrawing money without discussion with me, or my knowledge from the operating expenses. Before I caught him, he had withdrawn 10,000 in addition to the expected 13000 for wages. To stop him from withdrawing all of the money, I withdrew the funds that remained - 13000 - the minimal operating expenses set aside in our Operators Agreement.We disolved the company at the end of the year and have gone our seperate ways. I paid the taxes quarterly on our income for 2006, for 13000 each - as we had agreed the previous year. Now he is coming back to me and saying that he is being taxed for the 23000 and the 13000.In 2006 the entire 23000 from the previous year was used for legitimate business expenses - printing, raw materials, and payment to 3rd party contractors for work. I expected these funds to be written off in taxes - is this not the case?Since the 23000 was wiped out, it left a total profit for 2006 of 51000 - period - nothing from the previous year was left. It was out of this amount that his 10K +13K were withdrawn and my 13K and 13K were withdrawn. The account was depleted as of January 5th. Are there taxes owed, and who owes them? Since no one claimed the 23000 as wages or distributions in 2005, whose money is that if taxes are due?
05/15/2010   |   Category: Taxes   |   State: Texas   |   #22121

Answer:

The answer will depend in part on whether the LLC elected to be treated as a corporation or partnership. The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC business entity must file as a corporation, partnership or sole proprietorship tax return.

An LLC that is not automatically classified as a corporation can file Form 8832 to elect their business entity classification. A business with at least 2 members can choose to be classified as an association taxable as a corporation or a partnership, and a business entity with a single member can choose to be classified as either an association taxable as a corporation or disregarded as an entity separate from its owner, a “disregarded entity.” Form 8832 is also filed to change the LLC’s classification.

Single-owner LLCs pay taxes on Form1040 with the Internal Revenue Service. Partnership LLCs, in which there is more than one owner, must file partnership returns using Form 1065. Both of these are simpler than paying taxes through a corporate structure. Using these returns also avoids double taxation, under which corporations pay taxes on their income and shareholders also pay taxes when the corporation's profits are distributed to them through dividends. Because an LLC does not have shareholders, it has a different tax structure.

We are prohibited from giving tax advice, we suggest you consult with a tax professional who can review all the facts and documents involved.

Please see:

http://www.irs.gov/businesses/small/article/0,,id=109807,00.html
http://www.irs.gov/publications/p541/ar02.html#en_US_publink1000104233
http://www.irs.gov/publications/p542/index.html
http://www.irs.gov/publications/p541/index.html
http://biztaxlaw.about.com/od/taxesonbusinesstypes/a/llctaxation.htm