When deciding on a business structure, one of your primary concerns should be taxes. If you are considering a limited liability company (LLC), keep in mind that the Internal Revenue Service(IRS) doesn't have a special tax classification for LLCs. This gives you the freedom to choose how your LLC will be taxed.
An LLC may be taxed in four primary ways:
- As a sole proprietorship
- As a partnership
- As a C corporation (C corp)
- As an S corporation (S corp)
If you own a single-member LLC, you may elect to be taxed as a sole proprietorship, partnership, or C corp. If your LLC has more than one owner, a sole proprietorship isn't an option, but the remaining three are.
Here are some factors to consider when deciding how you want your LLC to be taxed.
- Tax rates.To choose your LLC's tax status, you should consider whether your business would be better served by IRS treatment as a "disregarded entity" or a corporation. A disregarded entity—meaning the LLC is disregarded as being separate from its owner—is treated the same as a sole proprietorship for tax purposes. In that case, yourLLC's incomeis treated as personal income. This "pass-through taxation" simplifies your tax return. On the other hand, if you choosecorporate status, your income is taxed at a lower corporate rate up to a certain amount as set by the IRS.
- Double taxation.Both the corporation and its shareholders pay tax on their income, leading to double taxation. A corporation also pays corporate taxes. An LLC can help you avoid double taxation unless you structure the entity as a corporation for tax purposes.
- Business expenses.LLC members may take tax deductions for legitimate business expenses, including the cost of forming the LLC, on their personal returns. Deductions, just like profits, are divided among owners based on a percentage of ownership. Note that for certain employee benefits—such as medical, disability, and life insurance—a C corp may be a better choice, or else the benefits could become taxable to LLC members. Moreover, LLC owners may also be eligible for the Qualified Business Income deduction, which allows LLC owners to claim a 20% deduction from their business net income, above and beyond business-expense deductions.
- Capital expenditure deductions.LLCs may take capital expenditure deductions for purchases of goods or equipment that the business will use over a one-year period. The deduction is divided over the course of the year, according to IRS provisions.
Once you make a decision ontax status, your next step is more paperwork. That is, if you want your LLC to be taxed as anything but a sole proprietorship, you must fileForm 8832to inform the IRS of your LLC's partnership or corporation status.
For most small business owners, structuring a business as an LLC offers the most versatility in determining how the business is taxed, while also offering the limited liability of a corporation but with less formality. Because every LLC is unique, you may wish to obtain solid legal advice before moving forward on tax status selection.
Find out more about Business Taxes
FAQs
The Tax Cuts and Jobs Act (TCJA) added the latest LLC tax benefits. This act allows LLC members to deduct up to 20% of their business income before calculating tax. If you don't choose S corporation tax status for your LLC, members can often avoid higher self-employment and income taxes with this deduction.
What are the key benefits of an LLC? ›
This article explores some of the benefits that an LLC can offer to its owners.
- Separate legal identity. ...
- Limited liability. ...
- Perpetual existence. ...
- Flexible management structure. ...
- Free transferability of financial interests. ...
- Pass-through taxation.
As an LLC owner, this is also a good way to get paid because you will only have to pay self-employment taxes on the salary you have designated for yourself. This can save you about 15% on your taxes compared to if you were to just take distributions.
What are the tax deductions for LLC? ›
The IRS allows LLCs to deduct initial start-up costs — e.g., marketing materials, travel, permits, legal fees, research — and thereafter allows deductions for a wide variety of operational costs, including: Computers, printers, and other office supplies. Phone and internet. Website development.
How do LLC owners avoid taxes? ›
The key concept associated with the taxation of an LLC is pass-through. This describes the way the LLC's earnings can be passed straight through to the owner or owners, without having to pay corporate federal income taxes first. Sole proprietorships and partnerships also pay taxes as pass-through entities.
How do LLC losses affect personal taxes? ›
If your business is a partnership, LLC, or S corporation shareholder, your share of the business's losses will pass through the entity to your personal tax return. Your business loss is added to all your other deductions and then subtracted from all your income for the year.
What are 5 disadvantages of LLC? ›
Disadvantages of an LLC
- Liability limited by business assets.
- The ability of the business to remain in existence if a shareholder departments.
- The creation of a centralized management structure.
- Flexible asset transfer.
An LLC has pros such as flow-through taxation and limited liability protection. However, there are also disadvantages such as the legal process of “piercing the corporate veil” and being forced to dissolve the LLC if a member leaves.
What are three things that LLCs are not required to do? ›
LLCs also provide a lot of freedom in management as there is no requirement to have a board of directors, annual meetings, or maintain strict record books.
How do I write off my car with an LLC? ›
Yes, an LLC can write off a car purchase as long as it is used for business purposes. The exact amount of the deduction will depend on whether you use the standard mileage rate or the actual expense method.
You pay yourself from your single member LLC by making an owner's draw. Your single-member LLC is a “disregarded entity.” In this case, that means your company's profits and your own income are one and the same. At the end of the year, you report them with Schedule C of your personal tax return (IRS Form 1040).
Can you write off car payments for LLC? ›
The Internal Revenue Service identifies taxpayers who qualify to claim a business vehicle write-off as: Self-employed individuals. Sole proprietors and owners of limited liability companies (LLCs) with a tax classification that allows pass-through income on Tax Form 1040 qualify for the write-off.
How many years can an LLC show a loss? ›
How Many Years Can You Claim a Loss With an LLC? As an LLC, you want to be careful to try not to report losses for more than two years. Otherwise, the IRS may decide to classify your business as a hobby rather than an actual business. If this happens, you can't deduct your business expenses for tax purposes.
Can my LLC reimburse me for expenses? ›
If your LLC agreement does not indicate such items are required, submitting an expense report for eligible expenses allows the LLC to reimburse you the costs and take the deduction on the LLC return.
Is it better to be a 1099 or LLC? ›
That will depend on your situation, but many entrepreneurs prefer LLCs because of the personal liability protection and tax flexibility they provide over being an unregistered independent contractor.
How does owning a business affect my personal taxes? ›
The business income or loss that you earn isn't taxed separately from your other income. This income “passes-through” to your personal income tax return because the business profits don't get taxed as a separate entity. Most often, you report your business income and expenses on Schedule C of Form 1040.
What are the benefits of an LLC vs self employed? ›
Forming an LLC gives legal protection to your personal assets and doesn't affect your taxes compared with operating as an individual or independent contractor.
Does an LLC need to file taxes if no income? ›
All corporations are required to file a corporate tax return, even if they do not have any income. If an LLC has elected to be treated as a corporation for tax purposes, it must file a federal income tax return even if the LLC did not engage in any business during the year.
