An LLC is a creature of state law. The IRS does not recognize "LLC" as a tax classification. Instead, every LLC inherits a default tax status based on member count, with the option to elect into something else. Get the default wrong on the exam and the entire return is misfiled. Get the self-employment tax treatment wrong and the owner pays thousands more than necessary.
The check-the-box regulations under Treasury Regulation Section 301.7701 govern how unincorporated business entities (LLCs, partnerships, business trusts) are classified for federal tax purposes. The system has two layers: a default classification and an optional election to override the default.
HIGH-FREQUENCY: The default classification depends on a single fact, the number of members:
- One member = disregarded entity. The LLC is invisible to the IRS.
- Two or more members = partnership. The LLC files Form 1065 and issues K-1s.
To override the default, the LLC files Form 8832 (Entity Classification Election). The election can change the LLC's federal tax treatment to a C corporation.
Common mistakes
- Treating all LLCs as disregarded. Only single-member LLCs are disregarded by default. Two or more members triggers partnership status and a Form 1065 filing. Candidates who skip the member count get the wrong return.
- Forgetting the 60-month lock. Once an LLC elects corporate status via Form 8832, it cannot revoke that election for 60 months. Exam scenarios with a Year-3 reversal are testing this rule.
- Applying SE tax to all LLC members equally. A managing member pays SE tax on distributive share; a truly passive non-managing member generally does not. The exam often gives a fact pattern with an active managing member and a silent investor, asking which member owes SE tax.
Bottom line
- Single-member LLC defaults to a disregarded entity. Multi-member LLC defaults to a partnership (Form 1065). Either can elect corporate status.
- Check-the-box election is made on Form 8832 (C corp); to become an S corp, file Form 2553. The election is irrevocable for 60 months from the effective date.
- A single-member LLC owned by an individual reports active income on Schedule C, rentals on Schedule E. No separate entity return.
- A managing member of an LLC taxed as a partnership is treated like a general partner, so all distributive share is subject to SE tax. A passive non-managing member generally qualifies for the limited-partner exception.
Exam shortcut
Three questions answer most LLC fact patterns: How many members? One = disregarded; two or more = partnership. Was Form 8832 filed? If yes, the LLC is a corporation (and possibly an S corp via Form 2553). Is the member managing or passive? Managing = SE tax on distributive share; passive = limited-partner exception. Memory cue: "Members, Forms, Roles." Members set the default. Forms (8832/2553) override the default.
The full lesson (about 2,245 words, 15 min read) adds 1 worked example, all 4 common mistakes, a self-check, free in the app.
Learning objectives
- V.E1
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