Tax Benefits and Drawbacks of an LLC (2024)

If you are planning to start a small business, choosing a legal entity for your business is one of the first steps you need to take. If you have an established business, it's important to evaluate your current legal entity, especially if you have a sole proprietorship or partnership and see if it's the best option. Many small to medium businesses choose limited liability corporations as their entity, and to help you determine if it's right for you, our accounting firm in Raleigh is looking at the advantages and disadvantages of an LLC.

What Is an LLC?

An LLC is a limited liability corporation and is a type of business structure or legal entity. This structure is designed so your personal assets are less at risk if your business is sued or is in debt. In a sole proprietorship or partnership, if your product injures someone and your business is sued or you owe a vendor money, your business assets are at risk, but so are your personal assets, such as your home and money in your personal accounts. We also advice you check with your attorney regarding the legal protection of your LLC.

An LLC separates your business assets from your personal assets so even if you are sued, the only assets the plaintiff can go after are those related to your business. Additionally, LLCs are easy and inexpensive to set up and offer flexibility in how many owners (called members) there can be. While most LLCs only have one member, there can be two, ten, or 100.

Tax Advantages of an LLC

In addition to the protections, let's consider how LLC taxes may be more beneficial to you compared to other entities.

Pass Through Entity

LLCs are "pass through entities." This means that all profits and losses of the business pass through to the member's personal tax return and are subject to personal tax rates. Single-member LLCs are taxed similarly to a sole proprietorship whereas multi-member LLCs are taxed like a partnership.

Specific Tax Deductions

With the Tax Cuts and Jobs Act of 2017, the Qualified Business Income Deduction went into place. Basically, this is a deduction of as much as 20 percent of the net business income earned by the LLC member or members so even after you deduct your business expenses, you may be eligible for an additional deduction of 20 percent.

Avoids Double Taxation

LLCs are the only type of corporation not subject to being taxed twice. In a traditional corporation, the company itself must pay corporate taxes on the income it receives, and the owners, who are shareholders, must pay taxes when they receive dividends of the company. Thus, they are subject to double taxation by avoiding the corporate tax.

Disadvantages of LLC Taxes

While LLC taxes do come with several advantages, there are some disadvantages to consider.

Self-Employment Taxes

Owners of an LLC often pay more in taxes than corporation owners because of self-employment taxes. Any salary or profit the owner earns from the business is subject to self-employment taxes of around 15.3 percent and includes Social Security and Medicare. Corporations' profits aren't subject to this tax, just the salaries, so it's often significantly less.

Immediate Distribution of Profit

Profits of an LLC are automatically included in your income and are thus, immediately subject to taxation. C-corporations do not have to distribute profits to shareholders immediately and so that money may not be taxed if profits decrease at a later time.

Schedule a Consultation to Discuss Your Business Structure's Taxes

If you own a sole proprietorship, LLC, or other type of business entity, and you're not sure if it's right for you, or you need assistance in setting up a business entity, reach out to our accounting firm in Raleigh today. We work with a wide variety of business entities, and provide comprehensive small business accounting services. Call us at 919-420-0092 or fill out the form below to get started.