As its name suggests, limited liability companies (LLCs) protect personal assets from debts and other business liabilities. But you may not be aware that LLCs can also offer tax savings. As an LLC, you have flexibility in choosing how you’ll be taxed. This allows you to reap a number of benefits unavailable to other business entities. This goes for both single-owner LLCs and those with multiple owners, also referred to as members or managers.
Here are a few of the biggest tax advantages available to LLCs:
Pass-through entities and choice of how to be taxed
LLCs are unique because the IRS doesn’t consider them separate entities for tax purposes, and in some cases, the IRS will not tax the LLC directly. Instead, the LLC’s members get to choose how they want to be taxed. Tax options include sole proprietorship, partnership, or as a corporation, and these options depend on how many people own the LLC.
Unless you choose to be taxed as a corporation, single-member LLCs are automatically taxed as sole proprietorships, while multiple-member LLCs are taxed as partnerships. The IRS considers these “pass-through” entities, meaning the business profit passes through the company directly to the owners and is taxed on the personal returns of the owners.
In such cases, your company doesn't pay taxes at all. Instead, your share of the net business income is taxed on your personal tax return, along with the rest of your income. You’ll pay taxes based on your personal income tax rate, and depending on how much total income you earn, this may be less than the corporate rate.
Alternatively, you can also elect for your LLC to be taxed as an S-corporation. In this case, you will be responsible for paying payroll, plus payroll taxes, and filing a tax return on behalf of the corporation (1120S). The good news about this way of doing things is that so long as you pay yourself a reasonable salary, you only pay payroll taxes on the amount of your payroll, not on your profit distributions from the company.
You will, of course, pay ordinary income tax on your profit distributions, but you save the 15.3 percent or so in payroll taxes. In contrast, when using an LLC taxed as a partnership or sole proprietorship, you will pay payroll taxes on all distributions to you from the LLC.
Again, the advantage of an LLC is its flexibility: You can qualify for the perks of multiple entity structures simply by choosing how you wish to be taxed. Typically, you’ll want to have at least $75,000 of net income per year before the S-Corp election makes sense, so if you’re close to that, contact us to discuss your options.
New pass-through tax deductiono
As of 2018, LLCs offer a new tax benefit. President Trump’s Tax Cuts and Jobs Act established a new income-tax deduction for pass-through entities, making LLCs even more attractive. LLCs can now qualify for a straight 20-percent deduction on “qualified business income” (QBI). This means some LLCs will only be taxed on 80 percent of their pass-through income.
However, this deduction is subject to several limitations, so not all pass-through entities will qualify. Be sure to consult with a Family Business Lawyer® and/or an accountant if you’re looking to take advantage of this new deduction.
Check state laws on LLC taxation
All of the above benefits are based on federal income tax law, but not all states handle LLCs equally. Depending on where you’re located, state law may offset some of these tax advantages. For example, in California there is an extra tax on revenue earned by LLCs.
Given this, you should check with us to find out exactly how our state taxes LLCs before choosing to set up an LLC.
Talk with us first
Whether you need help understanding state tax laws on LLCs or choosing which entity tax status is best, we offer you trusted counsel. With us as your Creative Business Lawyer®, we can ensure your company is able to take advantage of every possible benefit available. Contact us today to get started.
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