Questions often arise regarding how single-member and multiple-member LLCs should account for income taxes in their separate financial statements. ASC 272
, Limited Liability Entities
, provides some guidance for accounting for LLCs. ASC 272-10-05-4
indicates that LLCs are similar to partnerships in that members of an LLC are taxed on their respective shares of the LLC’s earnings (rather than the entity itself). Therefore, multiple-member LLCs generally do not reflect income taxes if they are taxed as partnerships (i.e., a partnership tax return is filed and the investors each receive a K-1) and are not otherwise subject to state or local income taxes. However, if a multiple-member LLC is subject to state or local income taxes (certain states impose income taxes on LLCs) the entity would be required to provide for such taxes in accordance with ASC 740
. This approach would apply irrespective of whether the members are part of the same consolidated group.
Single-member LLCs may be accounted for differently. The US federal tax law provides an election for single-member LLCs to be taxed as either associations (i.e., corporations) or “disregarded entities.” If the election is made to be taxed as an association, there is no difference between classification as a single-member LLC and a wholly-owned C corporation for US federal income taxes. If a single-member LLC does not specifically “check the box” and elect to be taxed as an association, it is automatically treated as a disregarded entity. This means that for US federal income tax purposes, single-member LLCs are accounted for as divisions of the member and do not file separate tax returns.
How single-member LLCs account for income taxes in their separate financial statements depends in part on the character of the single member. For example, if the member was a C corporation, the earnings and losses of the LLC would automatically roll up into the member’s corporate tax return, where they would be subject to tax at the corporate rate. From a US federal income tax perspective, there is no substantive difference between a single-member LLC that is treated as a disregarded entity and a division that is included in the consolidated tax return. In these situations, we believe that presenting a tax provision in the separate financial statements of a single-member LLC is the preferred accounting policy election.
Conversely, if the single member was a partnership, the earnings and losses of the LLC would automatically roll up into the member’s partnership return and be passed through to the individual partners. In these cases, we believe that the single-member LLC should not provide income taxes in its separate financial statements. In instances when the LLC is owned by a second single-member LLC, we believe the character of the member of the second LLC (for example, a C corporation or a partnership) should determine the presentation of income taxes in the separate financial statements of the lower-tier LLC.
The separate financials of all single-member LLCs should disclose the entity’s accounting policy with regard to income taxes (i.e., whether a tax provision is recorded). The accounting policy should be applied consistently from period to period.
In addition, single members that present a tax provision should also include disclosures consistent with those required by ASC 740-10-50-17
(discussed in FSP 16.7.3
). Single members that do not present a tax provision should consider including the following disclosures in their financial statements:
- The reasons why they chose an accounting policy not to record a tax provision (e.g., the single-member LLC is a disregarded entity for US federal and state tax purposes)
- Affirmation that no formal tax-sharing arrangement exists with the member
- A description of any commitments the single-member LLC has to fund any tax liability of the member with earnings of the LLC
The single-member LLC may also want to consider providing pro forma information reflecting the impact on its financial statements had it recorded a tax provision.
Example TX 14-3A illustrates the assessment of whether a wholly-owned multi-member LLC is an in-substance single-member LLC.
EXAMPLE TX 14-3A
Determining whether a wholly-owned, multi-member LLC is an in-substance single-member LLC
An LLC is 50% owned by two parties, Company X and Company Y (both C corporations). Company X is owned by another C corporation, Company Z. The LLC’s separate company financial statements appropriately do not provide for income taxes because it is a multi-member LLC and thus a flow-through entity for tax purposes. In a subsequent purchase transaction, Company Y was acquired by Company Z. After the acquisition of Company Y by Company Z, the LLC is ultimately wholly-owned by Company Z.
The following depicts the organizational structure.
After the purchase is completed, should the LLC reassess its determination as to whether to provide taxes in its separate company financial statements?
No. We believe that the determination of whether taxes should be provided in the LLC’s separate financial statements should focus on whether the tax law considers the entity to be a flow-through entity. In this case, Company X and Company Y continue to retain their respective interests in the LLC. Therefore, the LLC is still considered a partnership for US federal income tax purposes, and the separate financial statements of the LLC should not include any provision for income taxes
In December 2019, the FASB issued ASU 2019-12
, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.
This guidance specifies that an entity is not required to allocate income tax provision to a legal entity that is both not subject to tax and disregarded by the taxing authority, but an entity may elect to do so. See TX 14.5
and TX 14.5.1
for additional information on ASU 2019-12
, including effective dates, transition requirements, and post-adoption guidance.