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A Limited Liability Company (LLC) is a business structure allowed by state statute. LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Most states also permit "single member" LLCs, those having only one owner.
The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC business entity must file a corporation, partnership or sole proprietorship tax return.
See for reference - http://www.irs.gov/businesses/small/article/0,,id=158625,00.html
A single member LLC (SMLLC) can be either a corporation or a single member "disregarded entity". Again, to be treated under federal law as a corporation, the SMLLC has to file Form 8832 and elect to be classified as a corporation. An SMLLC that does not elect to be a corporation will be classified by the existing federal guidance as a "disregarded entity" which is taxed as a sole proprietor for income tax purposes.
That means - all income and deductible expenses are reported on owner's individual tax return as if there were not an LLC.
Generally - unless you choose differently - a multi member LLC is treated as a partnership for federal income tax purposes.
A partnership is the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business. A partnership must file an annual information return to report the income, deductions, gains, losses, etc., from its operations, but it does not pay income tax. Instead, it "passes through" any profits or losses to its partners. Each partner includes his or her share of the partnership's income or loss on his or her tax return.
The character of income realized by either a single member LLC (disregarded entity) or by a multi-member LLC (pass through entity) is not changed when passed to members.
If you want - however to be treated as you are in the trading business - you might consider Section 475(f) election - that would allow an additional advantage for a trader. In such an election, the trader's short-term capital gains/losses are converted into ordinary income/loss; losses that otherwise would have been limited to $3,000 are fully deductible against ordinary income in the current year. Also, the trader does not have to comply with the "wash sale" rules (which generally apply to prevent loss deductions on "substantially identical" securities bought within 30 days before or after a sale).
As a result of the Taxpayer Relief Act of 1997, a "trader in securities" qualifies as a trade or business that is eligible for tax breaks and 100% deduction of legitimate business expenses. A trader can also use trading losses to offset an unlimited amount of income.
6.To be eligible for section 475(f) treatment, a taxpayer must make an election by the due date of the previous year's return.A Trader is in the trade or business of buying and selling securities for their own account - you do not required to create any business entity or a partnership.--You are a trader in securities if you meet all of the following conditions: --You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation. --Your activity must be substantial. --You must carry on the activity with continuity and regularity. The following facts and circumstances should be considered in determining if your activity is a securities trading business: --Typical holding periods for securities bought and sold. --The frequency and dollar amount of your trades during the year. --The extent to which you pursue the activity to produce income for a livelihood --The amount of time you devote to the activity.
To make the mark-to-market election for the tax year, you must file a statement by April 15 of that year. This statement should be attached to either your previous year individual income tax return or a request for an extension of time to file that return. The statement must include the following information.
--That you are making an election under section 475(f) of the Internal Revenue Code.
--The first tax year for which the election is effective.
--The trade or business for which you are making the election.
After making the election to change to the mark-to-market method of accounting, you must change your method of accounting for securities under Revenue Procedure 2002-9 (or its successor). Revenue Procedure 2002-9 requires you to file Form 3115, Application for Change in Accounting Method. Follow its instructions. Label the Form 3115 as filed under "Section 10A of the Appendix of Rev. Proc. 2002-9."
http://www.irs.gov/pub/irs-irbs/irb99-07.pdf page 53
Having or not having the LLC by itself - would not change the treatment of your income and expenses.
The advantage of having an LLC for day traders - might be in making an election under section 475(f) to use the mark-to-market method of accounting.
The issue is that if you make such election as a person - it would be hard to revoke, some day traders are making such election for the LLC and if in future they want to revoke it - just close the LLC.
You may find helpful some additional information in this IRS article - http://www.irs.gov/taxtopics/tc429.html
Let me know if you need any help.
Thank you for your detailed answer.
In regard to SMLLC:
1. I thought that a SMLLC will always be treated as a sole proprietor by the IRS (self-employment tax)?
2. Can the IRS deny an 8832 election / filing?
In regard to section 475(f):
1. It seems to me that the requirements are not easy to quantify and hence a certain degree of relativity / flexibility exist?
In regard to the Mark to Market election:
Could you please expand on the advantages and disadvantages of making such selection.
Yes - if the election is not made according to instructions.
That is correct - requirements are relatively complex.
Some advantages I mentioned above.
In such an election, the trader's short-term capital gains/losses are converted into ordinary income/loss; losses that otherwise would have been limited to $3,000 are fully deductible against ordinary income in the current year. Also, the trader does not have to comply with the "wash sale" rules (which generally apply to prevent loss deductions on "substantially identical" securities bought within 30 days before or after a sale).
The disadvantages are that there will not be long term capital gain treatment and if you make such election - it would be very hard to revoke.
Just to make sure that I'm understanding you correct:
I should be able to file a corporate tax return for a SMLLC if my 8832 filling is per the instructions (no filling errors). Otherwise the IRS can not and will not deny. Hence there is no need to form a 2 members LLC just in order to avoid self-employment taxes.
And than, a 475(f) section and a 3115 election under it under the corporate framework will ensure gains, losses and all related expenses to be considered operational profit and loss items for the current year.
I should be able to file a corporate tax return for a SMLLC if my 8832 filling is per the instructions (no filling errors). Otherwise the IRS can not and will not deny.
That is correct.
Hence there is no need to form a 2 members LLC just in order to avoid self-employment taxes.
If your income is from trading securities - it is generally classified as a capital gain (long or short term) - and as such is not subject of self-employment taxes.
As I mentioned above - the character of income realized by either a single member LLC (disregarded entity) or by a multi-member LLC (pass through entity) is not changed when passed to members.
So unless your situation is different - I do not see any reason of changing the default classification of your LLC.
That is correct if such election is made regardless what tax treatment is selected for the LLC.