IRS Entity Elections
and Default Classifications 

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Unless an entity elects to be classified as a separate entity, distinct from its owner's for example, the IRS will auotmatically default the entity. What this means is shown by the following examples. 

1.  Bob's Ski and Repair Shop opened their business and there is only one owner, Bob. Bob did not make an election to be treated as a different entity, therefore the default classification for Bob would be that of a Sole Proprietorship. He would be required to file his business revenue and expenses using IRS Form 1040 Sch. C  He would also file this form if Bob has also formed an LLC but had not made the election.

2. In the above example, Bob now has a Partner, Bob's Wife. The same holds true for one. Bob and his wife start the business but did not elect to be classified as another entity and therefore the IRS will default the classification of Bob and his wife to that of a Partnership. They would be required to file their business on IRS Form 1065.  The same would hold true if Bob and his wife had started an LLC but had not chosen to be classified as another type of entity.

3. Bob decides that he doesn't like this idea. Under the first option above he would have to pay Self Employment Taxes on his Earnings, so he has asked his accountant what he should do. The accountant notifies him that he needs to file a form, IRS Form 8833 to change his default classification to that of an S-Corp. In process he also files form IRS Form 2553  so that he can be treated as a Small Business Corporation.

In such case of course Bob needs to refile his business with the State so that now look at it a Corporation; but Bob doesn't like that idea. He thinks an LLC would be better so he files that instead with the State and is now an LLC. His Accountant still tells him to file IRS Form 8833 for Entity Classification and also to file IRS Form 2553 so that he can not be taxed as an S-Corporation while still maintaining his status as a LLC with the State that he filed the LLC in.

4. No Bob you are not a Corporation in the Eyes of the Law. You are merely an LLC being treated as a Flow-Through S-Corporation when it comes to tax purposes. Other than that your LLC remains the same and is still subject to the same rules of the State as it was before you made the election.

Summation and Defaults

It sounds complicated and in some ways it is. But if you do not elect to be treated as another entity, the IRS will use their default rules and rate you under that for tax related purposes. The rules are as follows:

A.  Single Member LLC - Only One Member Or Manager in the Company
Default Classification for Tax Filings is Sole Proprietorship.

B. Bob and Wife in the LLC. - Two or more Members or Multiple- (multi) Member LLC.
Default IRS Classification is that of a Partenership.

One can choose various ways to be taxed. For example, a Multi-Member LLC or even Single Member LLC can be treated as a Corporation, or S-Scorporation.

Of Course forms need to be filed to have this take place. The Multi-Member is the same but they can also elect to be taxed as a Partnership as well. As Single Member may not do so as a Partnership of course signifies that more than one person or entity is involved in the company.

It should be noted that the rules are not that complex but fixing the elction later or revoking it can be a hassle. Make sure you know what you are doing before you choose any entity election as the taxes and consequences may not always be that friendly when taxes or liability issues arrise.

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