According to the U.S. Tax Code, virtually all entities that receive income must pay tax on that income. The term "entity" can refer to a person, or a financial construct, like a company, partnership or corporation. Under certain circumstances, an entity's tax obligation may be passed to its owner.
Limited Liability Company
A limited liability company, or LLC, is a firm that provides certain protections for its owner. An LLC may own property, obtain credit and engage in legal proceedings, but if the LLC is unable to fulfill its obligations, debtors or plaintiffs may not pursue the company's owners for recompense. In some cases, however, serious problems may cause the LLC to be liquidated and cease to exist. Courts may "pierce the corporate veil" to expand the liability of LLC owners.
Consolidated Tax Returns
Nearly all entities receiving income will owe tax on it. Certain business entities are allowed to pass their profits, and thus their tax burden, to their owners. The parent company or owner may then file a return for all sources of income. This return is called a consolidated return and may be beneficial for offsetting losses from some holdings against gains from others.
LLCs as Parents or Subsidiaries
An LLC may function as a parent or subsidiary. The LLC's profits and tax burden may pass from the company to its owner or the LLC may owe taxes on profits passed to it from its holdings. In this second case, the LLC may opt to file a consolidated return. An LLC does not have an obligation to file a consolidated return; in some situations, it is advantageous to regard certain holdings as independent entities responsible for their own tax.
Federal vs. State
State treatment of income tax liability often differs from the federal regulations. Most states allow consolidated returns, modeling their requirements on the federal regulations. Some will additionally require an "informational return" at the entity level. This means that partnerships, LLCs and other similar entities must file a return indicating that they are passing their profits and tax responsibility to the parent entity. Even if an informational return is not required, a form indicating the subsidiary's intent to pass profits and tax responsibility to its owner is mandatory.
- "Federal and State Taxation of Limited Liability Companies; David Cartano; 2008
- Federation of Tax Administrators; Current Developments Involving Pass-through Entities; June 2003