Own a business for a short time, and you soon realize that taxes can quickly eat into profits. When choosing a business structure, it's a good idea to consider taxes. Of all business entities, LLCs offer some of the best tax benefits for company owners.
An LLC (limited liability company) requires less tax paperwork than C corporations and S corporations. Even better, compared to other business structures, LLCs give business owners federal income tax flexibility. The IRS doesn't have a tax classification for LLCs. That means owners of LLCs have some choices as to how they choose to be taxed.
LLCs provide some excellent advantages for small business owners, but the main tax benefit of an LLC is that these business entities and their owners are subject to pass-through taxation. This means the company's earnings are "passed through" to the company owners with no required corporate federal income tax payments. Instead, the profits go directly to business owners, who then pay taxes on the earnings using their individual income tax rates.
This eliminates the double taxation that happens with other business structures, including C corps. In those cases, the corporation pays taxes on its income, and any money distributed to the owners is also taxed on their individual income taxes. By opening an LLC, you can avoid such costly double taxation.
Choose How You Want to Be Taxed
Because the IRS doesn't have a tax classification for LLCs, you have a choice as to how you'd like to be taxed. If you are the only owner of the LLC, you can be taxed as a sole proprietor. Companies with more than one owner can choose to be taxed as a partnership, an S corporation, or a C corporation. This choice is made by filing IRS Form 8832.
LLC as a Sole Proprietorship
If you are the only owner, you can choose to set up your LLC as a sole proprietor. This means reporting the business's profit and loss on your personal tax return and paying no corporate taxes. You file a Form 1040 individual tax form and a Schedule C business profit or loss form.
LLC as an S Corporation
LLCs set up to pay taxes as S corporations needn't pay any corporate taxes on income. All owners involved in the LLC (shareholders) report their share of their business income on their personal tax returns. There is no double taxation.
Multi-Owner LLC Partnership
This type of business structure provides another method of avoiding double taxation. The LLC files Form 1065 partnership return, and all owners pay taxes on their shares of the profits.
LLC as a C Corporation
If you choose to be taxed as a C corporation, you will pay double taxes. The corporation files a tax return and pays taxes on profits. Corporation members report their share of the corporate income on their individual tax returns as interest or dividends and then pay taxes on that income.
Additional LLC Tax Benefits
Even more tax advantages make forming an LLC to your advantage. When filing your taxes, ensure that your accountant doesn't miss any of the following additional tax benefits for your business.
Business Expense Deductions
Owners of LLCs can take deductions for legitimate business expenses on their personal tax returns. These include costs involved in forming the LLC, accounting and legal fees, vehicle expenses, professional journals, books, software, advertising, training and education, and dues for organizations.
Qualified Business Income Deduction
Also known as a Section 199A deduction or the QBI deduction, the Qualified Business Income Deduction is a fairly new tax deduction for business owners that came into effect with the 2017 Tax Cuts and Jobs Act (TCJA). This deduction applies to business owners who pay pass-through taxes on their personal tax returns, such as LLC owners. This allows for an additional deduction of up to 20% of qualified business income in addition to normal business expense deductions.
Capital Expenditure Deductions
When you own an LLC, you can take capital expenditure deductions if you purchase equipment or supplies that the business will use over a one-year period. According to IRS guidelines, the deduction is divided over the course of a year.
Tax Limitations of an LLC
You might not be paying corporate taxes as an LLC, but you still need to file a personal income tax return and pay taxes on business earnings. This includes owing taxes on distributive shares of the company profit, even if you don't receive a distribution of those profits. If you own a corporation, you only pay taxes on profits distributed in the form of dividends.
You must also pay a significant amount in the form of self-employment taxes, including social security and Medicare. With corporations, owners serving as employees only pay half of the self-employment tax, and the company pays the other half. LLC owners must pay for the employee and employer portions, which can be steep.
You will also need to pay state taxes and file quarterly tax payments of your estimated federal income taxes when you run an LLC.
There are limits on deductions. You may not be able to deduct health, disability, and life insurance benefits like you would if you owned a C corporation. If your LLC is set up to provide such benefits, you may have to pay taxes on those benefits.
When it comes to tax savings, LLCs are an excellent choice for many business owners. Consider talking to your accountant or tax expert to see if an LLC is the ideal choice for your business.
Just getting started and deciding if an LLC is right for you? Get guidance on forming a business entity by checking out our easy online registration process for LLCs. For more information about taxes and similar topics affecting businesses, visit the Swyft Filings Learning Center.