Legal Entity vs. Tax Classification | Understand the Difference

in this video i'm just going to be covering the difference between legal entity types and tax classifications a lot of you are reaching out to me or asking questions on the youtube channel and the comments and are confusing some concepts so i want to cover this all right so kind of give you a preview i want to explain to you that there are legal entity types those would be a sole proprietorship a single member llc a multi-member llc a corporation and then there are tax classifications so you form your legal entity with the state and you decide how you want that entity to be taxed at the federal level okay and i'll explain that here in a second i'm going to use my ipad and sort of map this out for us okay so let's first as i described i mentioned there are legal entity right and those would be a sole proprietor single member llc multi-member llc and corporation and when i say corporation here i mean like a c corp an inc if you will okay so these are the different um legal entity types and the point i want to drive home is you don't form these entities with the irs you typically form these legal entities by going to the state that you operate in and usually it's the secretary of state website and that's where you go online and you create one of these entities technically a sole proprietorship you wouldn't actually create at the state level you don't that's why it's doesn't have any liability protection because it is not an entity that gives you liability protection so you're not forming an entity anywhere but you could go to your state and apply for a dba doing business as or a fictitious name agreement or a trade name those are kind of synonymous terms different state use different terms but you could go to the state register a dba and still operate as a sole proprietorship right so these are your legal entity types what is the difference between a legal entity type and a tax classification because you can have an llc taxed as a sole proprietorship so what i'm do uh here below in the green color is um cover these uh tax classification so let's write tax classification okay and so here sole proprietorship is actually also a tax classification it's not just a legal entity type okay um we also have s corp so s corporation we have a partnership and we have c corporation so let's talk about now you know what these items are down here below so the tax classification is how you could elect to have some of these legal entities tax so let me just maybe map out in black what the default tax treatment is so i'm saying if you go out and you start just operating your business as a sole proprietorship then it will be taxed as a sole proprietorship okay you don't have to go to the irs and and tell them hey i want i want my sole proprietorship tax this way it's the only way your sole proprietorship will be taxed okay your single member llc by default will also be taxed as a sole proprietorship okay there's no box to check when you're filing this with the state or anything like that it's just the default you just have to know this that it will be taxed as a sole proprietorship a multi-member llc that means you went to your state and instead of just you um that is one of the members you decided to add someone as a as a second member second third fourth member okay by default this will be taxed as a partnership and you'll have to file a partnership tax return okay and then the c corporation or i should say the corporation by default without checking any boxes or anything like that it's going to get taxed as a c corporation now what you might want to do is have some of these entities you want to change their tax classification okay so instead of relying on the default tax classification that may not be beneficial or it may be costing you more tax you can um fill out some forms with the irs and have elect to have these entities these legal entities across the top tax as something different so a single member llc can be taxed as an s-corporation okay a multi-member llc can also elect to be taxed as an s-corporation and a regular corporation can actually elect to be taxed as an s corp okay there are some less common things that can be done here but these are going to be the most common ones so the point of this is by default you're gonna well the point is really this a couple things one is there's a difference between legal entities and tax classifications the second thing is if you go to your state they're only going to help you form a single member llc a multi-member llc or a corporation those are the most common ones okay you're not going to go to your state and say hey i want to form an corporation they're going to be like hey that's a tax thing we don't really focus on that here at the state level all right but what you can do is as you see in these red arrows here is have these legal entities taxed differently by electing this tax status it's typically going to be on a few different forms with the irs the most common one is form2553 and once you've got your llc set up for example you can then elect to have it taxed as an s corporation same thing with the multi-member llc and the corporation you can have a tax as an s-corp and the reason why you're doing that is to be in a more sort of taxed advantaged um you know tax classification because a single member llc will pay social security and medicare tax on all of its profits but in s corporation i should have said a single member llc tax as a sole proprietorship will pay social security and medicare tax as well as income tax on all of its profits whereas an s corporation if you elect to have your single member llc tax as an s corp can get some beneficial tax treatments but i don't want to really veer off the topic here there's many other videos on my youtube channel that you can go check out um to find out hey well why do people even elect to have their business taxes in s corporation or anything like that please keep in mind that if you go to your state and you find and you file as a corporation you create a corporation it's gonna be taxed as a c corp and be subject to double taxed okay so you probably don't want to do that you'll most likely want to elect to have that entity text as an s corporation so real quick video here guys just wanted to show you the difference between legal entity types and tax classifications again for more information on you know all these red arrows pointing to the s corp obviously i'm kind of signaling that there's probably a benefit in doing so check out the other videos on my youtube channel they'll explain you know why do people even form s-corporations all right with that said i will see you in the next video

Channel: Navi Maraj, CPA

Views: 2,206

Keywords: Legal vs Tax, LLC vs S Corp

Id: peyCpXGd6Ak

Length: 8min 11sec (491 seconds)

Published: Thu Jun 23 2022