In Brief:

A limited liability company (LLC) is a state created entity with pass-throughs like a partnership but with the limited personal liability of a corporation. Before deciding to change your form of business to an LLC, you should be aware of the disadvantages that exist in certain situations. 

In recent cases, the Tax Court has ruled that a ship captain may deduct the incidental expense portion of the federal per diem rates for meals and incidental expenses which he incurred while at sea, however a self-employed individual may not use the federal per diem rate to substantiate lodging expenses.
 

Limited Liability Company: An LLC is a state created entity that provides an individual with the legal protection of a corporation while being taxed directly on the LLC's income either through reporting the income and expenses on Schedule C for single member LLC's or through partnership reporting where there is more than one member of the LLC. In most cases, the LLC offers greater flexibility (no limit on the number of shareholders, no limit on the types of ownership interests, basis for third party debt), but an S corporation may still offer some advantages - especially for a single owner. Like an S corporation, an LLC will not insulate professional liability, although other liabilities will be limited. Except for single member LLC's, there is a presumption that an LLC is to be taxed as a partnership. For a single member LLC, the entity is disregarded for federal tax purposes and the income and expenses are reported directly on the owner's return on either Schedule C or Schedule E (if a rental activity is involved). Reporting the income and expenses on Schedule C may, however, have the unintended result of subjecting the LLC net income to the self-employment tax. It is mainly for this reason that an individual not engaged primarily in rental activities will generally find an S corporation to be more desirable than a single member LLC. For corporations engaged primarily in rental activities, especially C corporations, a double taxation issue may exist with respect to the sale of underlying real property which would not occur in an LLC; therefore the LLC is generally the more desirable form to operate under when the primary activity of the company is rental in nature. As with any tax matter, other issues may outweigh the potential additional taxes.

For most S corporations, conversion to an LLC will provide little, if any benefit, and may well prove to be undesirable. But for C corporations engaged primarily in real estate rental activities, conversion to an LLC could well provide the means for escaping the double taxation which would result to the shareholders on the sale of underlying real property.

Per Diem Expense Deductions: The Tax Court has determined that a ship's captain may deduct the incidental expense portion of the federal per diem rate for meals and incidental expenses (M&IE) he incurred while at sea, even though he did not have receipts to support the expenses. Although the captain's employers provided him with free meals and lodging while at work, he paid his other expenses including incidental travel items, laundry, dry cleaning, and the cost of transportation from the ship to the location of various services. The Tax Court noted that the captain had demonstrated the business purpose nexus between his incidental expenses and his travel through records showing his departure for and return from each city visited while away from his tax home (in this case, his personal residence), the cities or points of travel, and the business nexus between the employment and his travel. The Court further found that the M&IE rates may be used in three distinct situations: (1) when a traveling employee pays only for meals; (2) when a traveling employee pays for both meals and incidental expenses; and (3) when a traveling employee pays only for incidental expenses. The Court also noted that a taxpayer could deduct his actual expenses if they were more than the M&IE per diem rates, but that the taxpayer must be prepared to meet all of the substantiation requirements, especially having written documentation to support the deduction.

Similarly, the Tax Court has noted that self-employed individuals may not use the federal per diem rate to substantiate lodging expenses as lodging expenses are not included in the M&IE per diem rates. The self-employed individuals would therefore be limited to deducting the substantiated actual lodging expenses.