Do I Need an LLC for My Tax Preparation Business?

Starting a limited liability company (LLC) for your tax preparation business can provide several benefits.

Most importantly, an LLC structure offers limited liability to its owners, which can protect their personal assets from lawsuits and creditors.

For a tax preparation business, lawsuits can arise from things like professional negligence allegations (e.g., failing to put the correct information on a client’s tax return) or breach of contract issues (e.g., not completing a customer’s tax return by the deadline).

LLCs are also affordable, highly flexible (from a tax point-of-view), and can make your tax preparation business seem more credible.

Recommended: Use Northwest to form an LLC for $29 (plus state fees).

Should I Start an LLC for a Tax Preparation Business?

LLCs are a simple and inexpensive way to protect your personal assets and save money on taxes.

You should start an LLC when there's any risk involved in your business and/or when your business could benefit from tax options and increased credibility.

LLC Benefits for a Tax Preparation Business

By starting an LLC for your tax preparation business, you can:

Protect your savings, car, and house with limited liability protection
Have more tax benefits and options
Increase your business’s credibility

Limited Liability Protection

LLCs provide limited liability protection. This means your personal assets (e.g., car, house, bank account) are protected in the event your business is sued or if it defaults on a debt.

Tax preparation businesses will benefit from liability protection because of the risk of being sued for professional negligence, trademark infringement, libel, and personal injuries.

Example 1: A client decides to sue your tax preparation business for undelivered promises to acquire a far bigger tax refund than it actually did. In the misrepresentation lawsuit that follows, limited liability would prevent the court from being able to pursue your assets in order to satisfy any business obligation to pay damages.

Example 2: An employee at your tax preparation business input incorrect information on a customer’s tax return on their behalf that caused them to suffer large penalties. As a result, the customer sued your business for this negligence. In the lawsuit that follows, any requirement to pay damages that the court awards the client can only be imposed on your business’s assets.

Example 3: In a contract signed between your tax preparation business and a customer, it is agreed that your business will complete the customer’s tax return before the deadline. However, upon failing to do so, the customer sued your business for breach of contract. In the ensuing litigation, the court cannot seize your personal assets in order to satisfy any business liability.

An LLC will also protect your personal assets in the event of commercial bankruptcy or loan default.

To maintain your LLC's limited liability protection, you must maintain your LLC's corporate veil.

LLC Tax Benefits and Options for a Tax Preparation Business

LLCs, by default, are taxed as a pass-through entity, just like a sole proprietorship or partnership. This means that the business's net income passes through to the owner's individual tax return.

The business’s net income is then subject to income taxes (based on the owner's tax bracket) and self-employment taxes.

Sole proprietorships and partnerships are taxed in a similar way to LLCs, but they do not offer limited liability protection or other tax options.

S Corp Option for LLCs

An S corporation (S corp) is an IRS tax status that an LLC can elect. S corp status allows business owners to be treated as employees of the business (for tax purposes).

S corp tax status can reduce self-employment taxes and will allow business owners to contribute pre-tax dollars to 401k or health insurance premiums.

The S corp status requires that the business pay the employee-owner(s) a reasonable salary for the work they perform.

In addition, the business might need to spend more on accounting, bookkeeping, and payroll services. To offset these costs, you'd need to be saving about $2,000 a year on taxes.

We estimate that if a tax preparation business owner can pay themselves a reasonable salary and at least $10,000 in distributions each year, they could benefit from S corp status.

You can start an S corp when you form your LLC. Our How to Start an S Corp guide will lead you through the process.

Credibility and Consumer Trust

Tax preparation businesses rely on consumer trust. Credibility plays a key role in creating and maintaining any business.

Businesses gain consumer trust simply by forming an LLC.

A growing business can also benefit from the credibility of an LLC when applying for small business loans, grants, and credit.

Northwest will start an LLC for you for just $29 (plus state fees).

Get Started

How to Form an LLC

Forming an LLC is easy. There are two options for forming your LLC:

You can hire a professional LLC formation service to set up your LLC for a small fee
Or, you can choose your state from the list below to start an LLC yourself

Select Your State

For most new business owners, the best state to form an LLC in is the state where you live and where you plan to conduct your business.

Do LLCs Need Insurance?

All businesses need insurance to protect their business assets — even LLCs. This is because the limited liability protection from an LLC protects your personal assets, not your business assets.

Insurance has an array of positive benefits that tax preparation businesses can take advantage of. Its primary draw is the financial stability it provides as a result of its protection against unexpected liabilities such as negligence or poor advice given to clients.

Common Situations Business Insurance May Cover for a Tax Preparation Business

Example 1: During an appointment, your client falls in the bathroom, breaking several bones. General liability insurance would cover the cost of their medical bills.

Example 2: An employee leaves the coffee maker on at the end of the night. A fire breaks out, causing massive damage to your unit and a neighboring business. General liability insurance would cover the cost to repair or replace the damaged property, should your landlord name you in a lawsuit.

Example 3: Tax season is coming up, and you’re looking to hire more employees. To take part in an upcoming job fair, you are required to show evidence of liability insurance. General liability insurance would help fulfill this requirement.

Other Types of Coverage Tax Preparation Businesses Need

While general liability is the most important type of insurance to have, there are several other forms of coverage you should be aware of. Below are some other types of insurance all tax preparation businesses should obtain.

Professional Liability Insurance

In this industry, your clients rely on your professional expertise to ensure their taxes are properly prepared. If they feel they have been harmed due to your professional negligence, even if the claim is meritless, they may take you to court for damages. Professional liability insurance, also known as errors and omissions (E & O) insurance, will pay for your legal representation and costs associated with the suit, including damages awarded by the court.

Data Breach Insurance

As a tax preparer, you and your staff rely heavily on technology for the day-to-day operations of the business and maintain a great deal of personal client data. Unfortunately, this also makes you vulnerable to online hackers, an attack that is specifically excluded from a general liability policy. Data breach insurance, also known as cyberattack insurance, fills that insurance gap, covering damages from a data breach that results in stolen user data.

Commercial Property Insurance

Commercial property insurance pays to repair and/or replace business assets after an unexpected covered loss such as fire, natural disaster, or theft. The policy can be tailored to meet the organization’s specific needs, including coverage for any business-owned property kept onsite and real estate owned by your business.

Commercial Auto Insurance

Vehicles used for business purposes are specifically excluded from personal auto policies. If you use your vehicle for business purposes, you must obtain commercial auto insurance to fill any gaps in coverage. This policy covers the cost to repair or replace third-party property, the company’s damaged vehicle, and any equipment damaged in an accident. Purchasing the state-mandated minimum coverage leaves many entrepreneurs underinsured. Therefore, we encourage you to discuss policy coverages at length with your insurance professional.

Workers Compensation Insurance

State law mandates that all full-time and part-time employees be covered under a workers’ compensation policy. This policy pays medical bills stemming from an on-the-job injury or illness and a percentage of the employee’s lost wages while the injured party is unable to work. For accidents that result in lawsuits, it also ensures the business owner is properly defended in court and pays awarded damages.

Crime Insurance

Employee dishonesty, forgery, and fraud are specifically excluded from a standard business owner’s policy. Crime insurance provides coverage for such a loss, reducing the chances of a gap in coverage.

Should I Start an LLC FAQ

Choosing the right business structure depends on your business’s unique circumstances and needs. However, unless your business is very low risk (like a hobby), an LLC is likely the better option.

Visit our LLC vs. Sole Proprietorship guide to learn more.

At a minimum, you’ll need general liability insurance, professional liability insurance, and data breach insurance.

Read our Business Insurance article for more info.

Starting your tax preparation business can be done with a modest amount of startup capital — $6,000 is often sufficient. That being said, there are some unavoidable costs to consider, primarily office rent, business cards, equipment for the office, tax preparation software, insurance, and business licensure.

Visit our How to Start a Tax Preparation Business guide to learn more about the costs of starting and maintaining this business.

If you have an office, you will have to pay for rent and utilities. You also will have payroll expenses if you have employees.

Learn more about running a tax preparation business.

Tax preparation businesses make money by charging clients a fee for their tax prep services.

Learn more about starting a tax preparation business.

A tax preparation business will do people’s taxes for them correctly, relieving them of this annual chore.

Client volume, how much you charge per client, and overhead costs determine profits.

Learn more about starting a tax preparation business.