An LLC, is classified for tax purposes as a partnership, it is not subject to federal income tax. Persons carrying on their business as members shall be liable for income tax only in their separate or individual capacities. As an entity the LLC computes and characterizes taxable income and files a tax return (Form 1065) which is essentially an information return. Computing the LLC’s amount of profits or losses is important in determining how much profits or losses should flow through to the members. Once the LLC’s amount of profits or losses has been determined, the profits or losses can then be allocated proportionally to the members according to the allocation determined by the Limited Liability Company Operating Agreement.
In general, LLC taxable income is computed in the same manner as an individual’s taxable income with certain modifications. The most important modification is that items described in Internal Revenue Code Section 702(a) are separately stated. The reason for separately stating these items is that they have special significance to individual members. Internal Revenue Code Section 703(a) also denies two types of deductions that individuals are normally permitted. The first type of deductions is those that are considered inappropriate for LLCs, such as the deduction for personal exemptions and the itemized deductions. The second type are those deductions which the benefits are passed through to the members in their individual capacities, such as certain foreign taxes, charitable contributions, net operating losses, and depletion and of oil and gas wells.