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As a small business owner, you make many important business decisions. One such decision – your business structure – is critical to your operations. You must determine the best entity type and the tax benefits of each.
Registering a limited liability company (LLC) can offer liability protection. The tax benefits of an LLC include flexibility in your business structure and avoiding double taxation.
As you consider registering your business as an LLC, don’t let complicated tax rules hold up your business registration. This guide will help you understand the benefits of setting up an LLC.
What Is an LLC?
A LLC is a legal entity with multiple income tax structure options. You can establish an LLC by obtaining an EIN and filing registration documents with your Secretary of State.
Tax Benefits of an LLC
The primary tax benefits of registering an LLC include the following:
Additionally, LLCs offer legal separation between the company and its owners. The structure provides liability protection, allowing LLC owners to shield their personal assets from lawsuits directed at the company.
We’ll cover each tax benefit in more detail below.
Ease of Registration
You can set up an LLC by contacting your Secretary of State. Setting up an LLC helps business owners avoid time-consuming entity formation paperwork associated with other tax structures.
The LLC registration process typically represents a simple application and filing fee. Many states offer an online application. Review your Secretary of State’s guidance to determine the local requirements for your business.
Be sure to obtain an EIN and establish a registered agent before starting the LLC process. 1-800Accountant offers a budget-friendly EIN filing service to help you set up quickly.
Pass-Through Taxation
LLCs default to pass-through entities for federal income tax purposes.
A pass-through entity does not pay federal income tax on its business profits. Instead, the company passes income and deductions to the business owners. The pass-through entity owners must report their distributions on their personal income tax returns.
Pass-through entity taxation generally benefits small business owners by avoiding double taxation.
What Is Double Taxation?
Double taxation represents the tax system applicable to most corporations:
Pass-through entity taxation allows business owners to avoid double taxation. Since pass-through entities do not pay federal income tax, business owners receive pre-tax distributions.
Pass-through entity owners must pay personal income tax on their share of pre-tax business income. However, the distributions are subject to income tax only once.
Flexibility in Tax Structure
LLCs offer flexibility for business owners to choose the optimal tax structure.
If you set up an LLC, you can choose from several business entity types, each having unique tax advantages. For example, pass-through entities avoid double taxation, but business owners may elect corporate tax treatment for legal or economic reasons.
Consider partnering with professional CPAs for your business structure decisions. 1-800Accountant professionals offer low-cost tax advisory services to help you find the most beneficial structure for your business.
LLC Tax Advantages: How to Choose the Right Small Business Structure
LLCs enjoy flexibility in federal income tax treatment. LLCs default to pass-through entities for federal income tax purposes, but your small business can elect corporate taxation.
Your LLC’s tax structure depends on its elections and the number of owners. Review the following entity descriptions to determine the best structure for your small business.
When you’re ready to register your business, use 1-800Accountant’s Entity Formation and EIN Filing Services for help from business registration professionals.
Single-Member LLC (Sole Proprietorship)
LLCs with one individual owner default to sole proprietorship treatment. Single-member LLCs are disregarded entities for federal income tax purposes, meaning they do not file separate federal income tax returns.
The single-member LLC owner, or sole proprietor, must report the LLC’s business activity on Internal Revenue Service (IRS) Form 1040, Schedule C. The business owner pays income tax on the LLC’s profits.
Multi-Member LLC (Partnership)
LLCs with more than one owner default to partnership tax treatment. Multi-member LLCs must file partnership returns using IRS Form 1065. Partnership returns report income, deductions, and ownership information. The LLC must issue a Schedule K-1 to each member, reporting each partner’s share of LLC income and deductions.
Each owner must report their share of partnership activity on their personal tax return. LLC members pay taxes at their individual income tax rates.
LLC Taxed as a C Corporation
A single- or multi-member LLC can elect corporate tax treatment by filing a C corp tax election.
A C corp tax election changes the LLC’s federal income tax treatment from pass-through to C corporation. After the LLC files a C corp tax election, it must file a corporate tax return using IRS Form 1120. C corporation returns calculate business taxable income and tax liability.
Business owners pay tax on corporate dividends received from the business.
LLC Taxed as an S Corporation
Entities meeting the S corp requirements can file an S corporation tax election. Like LLCs, S corporations are pass-through entities that distribute income and deductions to each owner.
S corporations use IRS Form 1120-S to report business income and ownership information. S corps must issue a Schedule K-1 to each owner, reporting each member’s share of business income and deductions.
Each owner must report their share of S corporation activity on their personal tax return.
LLC Business Tax Deductions & Tax Write-Offs Explained
Regardless of your LLC’s tax structure, you can benefit from business tax deductions. Business write-offs reduce your taxable income and lower your tax bill.
Many operational business expenses represent tax deductions. Consider the following examples and consult tax professionals to improve your bottom line.
Qualified Business Income Deduction
The qualified business income (QBI) deduction allows business owners to deduct up to 20% of their income from a qualified business.
Owners of single-member LLCs, partnerships, and S corporations may qualify for the QBI deduction. To calculate your deduction, multiply your net business income by 20%. The result generally represents your QBI deduction. (Note that you cannot lower your taxable income below zero with the QBI deduction.)
Eligible business owners must report their QBI deductions on their personal income tax returns using IRS Form 1040.
Home Office Deduction
Home-based business owners can deduct expenses related to maintaining a home office. For example, your small business can deduct part of your home utilities, mortgage interest, and insurance premiums.
To calculate your home office deduction, determine the percentage of your home you use for business-only activities. Apply the ratio to your home expenses to determine your home office costs. Alternatively, you can use the simplified deduction method: Multiply the square footage of your home office by $5 and deduct the result (limited to $1,500).
Report your home office deduction on IRS Form 1040, Schedule C.
Self-Employment Tax Deduction
Unlike traditional employees, business owners do not remit payroll taxes through paycheck withholding. Instead, self-employed professionals must pay self-employment tax on their business earnings. Self-employment tax represents 12.4% of Social Security and 2.9% of Medicare taxes on all compensation.
Small business owners can deduct half of their self-employment tax burden on their personal income tax returns.
Startup Costs
New businesses can deduct certain startup expenses incurred before beginning operations. Business owners may deduct business startup costs of up to $10,000 and organizational costs of up to $5,000. The expenses must relate to the business operations and meet IRS eligibility criteria.
We recommend consulting small business advisory experts who can help you maximize your business tax deductions.
Other Common Business Expenses
Track your small business expenses and deduct operational costs on your business tax return. Examples of other common business tax deductions include the following:
Top States to Register an LLC
Business owners should consider state income taxes when deciding to establish an LLC.
State income tax rates and rules vary. Your state income tax burden depends on the individual income tax rates and LLC laws imposed by your state. Most states follow pass-through entity tax treatment for LLCs, meaning the states impose income tax on the LLC owners but not the LLC.
Several states do not impose an individual income tax, which means LLC owners do not pay state income tax on LLC profits. The following states represent taxpayer-friendly locations to register your LLC:
The following states do not impose a corporate income or gross receipts tax. These states represent taxpayer-friendly locations to register an LLC with a C corp tax election:
We recommend partnering with tax professionals who can help you understand your state’s income tax laws.
Consult the Experts at 1-800Accountant
Whether you’re starting a new business or restructuring an existing entity, consider the tax benefits of an LLC during your entity formation decision. Professional CPAs at 1-800Accountant can help you weigh the pros and cons of starting an LLC. Tax advisory professionals help you determine the best entity structure for your business.
Maximize your business tax deductions and improve your bottom line by partnering with 1-800Accountant. Schedule a free call for entity formation services and let tax experts support your LLC registration.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.