The new federal tax law creates a business income deduction of twenty percent for small businesses. This is a tremendous help to small businesses, particularly in New Jersey. But for limited liability companies which have elected to be taxed as an S-Corporation, there could be a problem.
LLCs Opting to be Taxed as an S-Corporation
Limited Liability Companies (LLCs) often start by being taxed as a sole proprietor or partnership. When the company grows, it may elect to remain an LLC, but be taxed as an S-Corporation. This is accomplished by filing a single page election form (8832) with the IRS. However, many companies filing this election then failed to amend their operating agreements to reflect the change. The IRS is denying the twenty percent tax deduction based upon this lapse. In addition, the IRS will view such companies as C-Corporations, subjecting the business to immensely higher taxes.
LLCs Electing to be Taxed as S-Corporations Must Act as S-Corporations
The Limited Liability Company, as a form of business entity, is often chosen by start-up businesses due to its flexibility and protection of personal assets from the liabilities of the company. There are no legal requirements as to the number of owners, the type of owners, or other requirements usually found for other business entities. However, when an LLC elects to be taxed as an S-Corporation, the LLC must act like an S-Corporation. The provisions in the operating agreement must be changed to reflect these legal requirements.
Amend Your Limited Liability Operating Agreement
For example, references to a capital account, standard language in LLC operating agreements, must be removed. All references to Sub-chapter K, and Section 704 of the IRS Code must be eliminated. All distributions to the owners must be made pro-rata, in accordance with their percentage ownership in the Company. There can be no system making distributions according to the business generated by an owner, or by any other system. There are also limitations on the number of owners, and no businesses can be owners of the LLC. There are other provisions as well.
If your limited liability company has elected to be taxed as an S-Corporation, you must have your operating agreement changed immediately. Our office would like to assist you. Please contact us, and we will prepare the necessary documents for you. We will also give you instructions and guidelines for operating your business in conformance with the law.