LLC Tax Benefits
If you’re thinking about starting an LLC, you’re probably wondering if an LLC will help you save money on taxes.
LLCs do offer tax benefits when compared to other business structures. For example, LLCs can be taxed as S corporations, which can offer significant savings to business owners. LLCs can also create more clearly defined boundaries between personal and business expenses when reporting to the IRS.
Our LLC Tax Benefits guide explains in detail the tax benefits of LLC formation by providing information on LLC tax options, deductible expenses, and more.
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Three Tax Benefits of an LLC
For many small business owners, the default business structure is a sole proprietorship. But, there are other options available that offer significant tax advantages. One of those options is a limited liability company (LLC).
Here are three key tax benefits of an LLC:
1. Flexibility
When you form an LLC, you have the option of electing to be taxed by default or as an S corp or C corp. This flexibility can be helpful in managing your overall tax burden.
The first option is the “default” status. LLCs are pass-through entities by default, so the LLC's income and its losses are transferred through to the individual tax returns of each member and are taxed at the owner's personal tax rate. This means that you will file your taxes on your personal tax return. As a pass-through entity, an LLC taxed by default doesn't have to pay federal income tax at the business level.
There are also the tax advantages of qualified business income deduction, self-employment tax, other tax deductions, and tax credits.
By default, single-member LLCs are treated as disregarded entities, and multi-member LLCs are treated as partnerships. Accordingly, single-member LLC owners will report their business income using Schedule C of their personal tax returns. Multi-member LLCs file Form 1065 to report the business’s total income, then each owner reports their share using Schedule E of their personal tax return.
The second option is to be taxed as an S corporation. An S corp is an LLC or corporation that has filed a special tax election with the IRS. This allows the business to circumvent double taxation, which means the business pays taxes on its income only once. The S corp designation also offers other benefits, such as protection from personal liability, flexibility in how the business is structured, and S corps can elect to have their income taxed at the lower corporate tax rate. This can save the business money on taxes, which can be reinvested back into the business.
The third option is to be taxed as a C corporation. This means that you will file a corporate tax return independent of your personal income tax return.
A corporation must file Form 1120 annually to record its business income and claim its credits
2. S Corp Taxation
As previously mentioned, “S corporation” is a type of IRS tax classification. Being an LLC taxed as an S corporation offers money-saving benefits under the right circumstances.
Electing S corp status leads to the business owner being labeled as an employee of the company. The S corporation must then pay the business owner a “reasonable salary” per IRS guidelines. The business owner pays income taxes and payroll taxes (FICA and Medicare) on their salary. Anything left over after the salary has been paid is paid as a distribution. There are no self-employment taxes on distributions, which is how an S corp saves business owners money.
In contrast, an LLC owner taxed by default would pay income taxes and self-employment taxes on their entire share of the company’s profits.
S corp status also allows business owners to contribute their pre-tax dollars to retirement accounts or health insurance premiums.
The S corp business owner might need to invest more in accounting, bookkeeping, and payroll services. To offset these costs, they would need to save about $2,000 per year on taxes. If a business owner has at least $10,000 left over in profit after paying themselves a reasonable salary, then the tax savings on that $10,000 will cover the additional costs of payroll and accounting.
Use our free S corp calculator to determine if electing S corp status would be beneficial to your business.
3. Avoiding Double Taxation
Avoiding double taxation is another benefit of forming an LLC. If you choose to form a corporation, you will be subject to double taxation on your profits because corporations are taxed at the business level, and shareholders are taxed again on their distributions. This isn’t the case with LLCs.
Because LLCs are pass-through entities by default, the LLC itself is not subject to federal income taxes. Instead, the profits and losses of the business are "passed through" to the individual members of the LLC and reported on their personal tax returns, avoiding “double taxation.”
On the other hand, pass-through taxation doesn’t work well for businesses that need to attract investors. In an LLC, investors would be taxed on their share of the profits even if they didn’t receive a distribution. Corporations are more attractive to investors because investors would only be taxed on their dividends/distributions.
If your business needs investors, you’ll want to form a corporation, but in general, all other small businesses will benefit most from starting an LLC.
Recommended: Xendoo is a professional accounting and bookkeeping service that helps you file for tax credits or deductions based on what's best for your business
More LLC Benefits
An LLC, or limited liability company, is a popular business structure among small business owners and entrepreneurs due to its overall flexibility and simplicity. Some additional benefits of an LLC:
- Limited liability protection
- Inexpensive to form
- Easy to form
- Less paperwork
- Management flexibility
- Credibility
Limited Liability Protection
LLCs offer limited liability protection, which protects the business owner’s personal assets against lawsuits and creditors. Informal business structures like sole proprietorships and general partnerships don’t provide this type of liability protection.
Keep in mind that owners are liable to lose liability coverage if they do something to violate the protection of the LLC's corporate veil. This includes mixing personal funds with corporate accounts and committing fraud.
LLCs also have charging orders, which safeguard an LLC's assets and the membership interests of members who face debts by indirect other members.
Inexpensive to Form
It's inexpensive to form an LLC — especially when compared to the cost of forming other business entities.
Easy to Form
Forming an LLC is easy. You can do it yourself or hire a professional, but either way, it's a simple process.
There are a few things you need to do to form an LLC: choose a business name, file paperwork with your state, and get an Employer Identification Number (EIN) from the IRS.
You also need to create an operating agreement, which outlines how your LLC will be run. This is important because it helps protect you and your business in case of any legal problems. However, your operating agreement doesn’t need to be filed with the state.
Less Paperwork
When it comes to the amount of paperwork required to form and maintain a business, LLCs require less than many other business entities. This can be a big advantage for business owners who want to avoid the hassle and expense of excessive paperwork.
To form an LLC, you'll need to file the Articles of Organization with your state's Secretary of State (or relevant filing department). This document is typically short and simple, and it's usually possible to file it online. Once you form your LLC, you may need to prepare annual reports depending on your state's requirements. But overall, the amount of paperwork required for an LLC is fairly minimal.
Management Flexibility
LLCs offer management flexibility for business owners who want to maintain some control over their company but want a different level of responsibility than a corporation. LLCs are also less expensive to set up and maintain than corporations.
The management structure of an LLC can be customized to fit the needs of the business owner. For example, an LLC can be managed by a single member or by a group of members. The management structure is decided when the LLC is formed and can be changed if the members agree to it.
A business structured as an LLC has the advantage of being able to adapt its management structure as the business grows and changes. This flexibility can be a valuable asset for companies that are constantly evolving and need to be able to change their management structure quickly and easily.
Credibility
An LLC is a business structure that can provide credibility for your business. When you form an LLC, you are taking the first step to show potential customers and clients that your business is serious.
An LLC can also help you build credibility with suppliers and vendors. When they see that your business is an LLC, they will know that you are a legitimate business owner who is committed to your business. This can help you get better terms and discounts from suppliers.
Lastly, forming an LLC can help you attract investors. Investors want to know that your business is a safe investment, and an LLC can give them the peace of mind they need to invest in your company.
Ready to form an LLC? Read our How to Form an LLC guide.
LLC Tax Deductions and Credits
When it comes to taxes, LLCs can deduct certain business expenses and take advantage of tax credits, much like other business structures. The benefit of forming an LLC vs. running a sole proprietorship is that business and personal expenses are better defined when filing taxes.
Deductible Business Expenses
Though not exclusive to LLCs, it's important to be aware of the many business expense deductions you can claim on your corporate federal income taxes through your LLC.
Here's a look at some legitimate business expenses that can be deducted from your taxes per the US Internal Revenue Service (IRS):
- Business travel expenses: If you travel for business, you can deduct your airfare, hotel costs, and travel expenses.
- Business equipment and supplies: You can deduct the cost of any equipment or supplies you purchase for your business.
- Business insurance: You can deduct the cost of business insurance premiums from your taxes.
- Health insurance premiums: As an LLC member, you can deduct health insurance premiums paid by the LLC. However, you cannot deduct any medical costs associated with personal injuries.
- Rent or lease payments: If you rent or lease office space or other property for your business, you can deduct those payments from your taxes.
- Advertising and marketing expenses: You can deduct the cost of any advertising or marketing campaigns you run for your business.
- Charitable contributions: You must pay taxes for personal charitable contributions since they are not deductible by the business. You may deduct charitable contributions paid by the business entity so long as you itemize these tax deductions on Schedule A (Form 1040).
Tax Credits
Tax credits are incentives offered by the government to encourage businesses to invest in certain areas or activities. The most common business tax credits are for research and development, job creation, and energy efficiency.
Federal and state governments offer tax credits to businesses as an incentive to encourage investment in certain areas or activities. The most common business tax credits are for research and development, job creation, and energy efficiency. Tax credits can be a powerful tool to help businesses grow and thrive.
When used correctly, tax credits can save businesses thousands of dollars on their taxes. However, it's important to consult with a tax advisor before claiming any tax credit, as there are often specific requirements that must be met in order to qualify.
LLC Tax Benefits FAQ
An LLC, or limited liability company, is a business structure that combines the flexibility of a sole proprietorship with the limited liability of a corporation. LLC owners are not personally responsible for the company's debts and liabilities. This means that if the LLC goes into debt, the owner's personal assets are safe from creditors.
However, this does not mean that owning an LLC makes you exempt from paying taxes. Your income from the LLC will be reported on your personal tax return. You will be responsible for paying federal and state income taxes as well as self-employment taxes on your share of the LLCs taxable income.
How much an LLC can write off depends on the type and amount of expenses incurred during the course of business. For example, common write-offs for an LLC include office expenses, supplies, travel, and marketing costs. Additionally, LLCs can also write off any losses incurred during the year.
Overall, the amount an LLC can write off will vary depending on the specific circumstances. However, by taking advantage of the many tax benefits available to them, LLCs can save themselves a significant amount of money come tax season.
If your LLC is generating a profit, you may be able to deduct a portion of your salary as well. This is known as a pass-through deduction and can be a significant amount depending on how much profit your LLC is making.
There are two disadvantages to starting an LLC.
An LLC initially costs more to form than a sole proprietorship and will take a little more effort to maintain. But, a sole proprietorship won't create any legal separation between you and your business. In the event of a lawsuit, operating as a sole proprietorship will expose your personal assets (car, home, personal savings) to creditors and the courts. Therefore, starting an LLC is the smartest financial choice in this situation.
The second disadvantage involves investors and taxes. In an LLC, all members are taxed based on their ownership interest in the business. If an investor owns half of the business, then they are taxed on half of the LLCs income regardless of whether they receive a distribution (money). This would be a disadvantage to investors for obvious reasons. To avoid this disadvantage, businesses that rely on venture capital (investors) should form a corporation.