From 1995 to 2021, small businesses created 63% of the total new jobs that appeared on the market. This speaks volumes about how these businesses keep the country running, and there’s no better time to get in on the action than now.
There are several business structures available though, and it may be tough to decide which is right for you. One fantastic direction option is a limited liability company (LLC), as it’ll provide you with protection for your personal assets.
But what about taxes? Below are the LLC tax benefits you can expect from this business entity type.
Limited Liability Protection
This isn’t actually a direct tax benefit; however, it’s a huge advantage to other business structures.
LLCs offer limited liability protection to their owners. Your personal assets are generally separate from your business’s debts and liabilities. So in the event of lawsuits or creditors, your personal assets typically can’t be used to satisfy the LLC’s debts.
Pass-Through Taxation
An LLC is treated as a pass-through entity for tax purposes. Any profits or losses of the LLC will “pass through” the business onto the owner(s). What this means is that you’ll pay taxes on your individual tax returns, and the LLC itself won’t pay taxes at the entity level, unlike corporations.
What does this mean for you? Well, you can avoid the issue of double taxation that can occur if you have a C corporation. With this structure, profits are taxed at the corporate level and then again at the individual level when distributed as dividends.
Flexibility in Taxation
A huge benefit of having an LLC is that there’s the flexibility to choose how you want it to be taxed. The tax elections available include sole proprietorship, partnership, S corporation, or C corporation if you’ve got a larger LLC.
This flexibility allows LLC wonders to select the tax treatment that best suits their business needs and tax situation.
Deductibility of Business Expenses
LLCs can deduct ordinary and necessary business expenses from their taxable income. This includes expenses such as rent, utilities, salaries, supplies, and other costs incurred while operating your business.
Deducting these expenses can help reduce the company’s taxable income, as well as its overall tax liability.
Do note that how you make these claims will depend on how your business is both classified and taxed. For example, if you’ve left it as a pass-through entity, then you can deduct business expenses on your own tax returns. But if you’ve chosen to have your LLC taxed as a corporation, then you’ll need to deduct those expenses on the business level.
Another important thing to note is the Tax Cuts and Jobs Act of 2017. This act brought in the Qualified Business Income (QBI) deduction for not only LLCs, but also sole proprietorships, partnerships, and S-corps. All business types can deduct up to 20% of their QBI.
Self-Employment Tax Savings
LLC owners who actively participate in the management of the business may be able to save on self-employment taxes.
Salaries paid to employees are usually subject to payroll taxes, including Social Security and Medicare taxes. However, the profits distributed to LLC owners are typically not subject to self-employment taxes.
But before you breathe easy, you should know that the IRS may scrutinize distributions to LLC owners. They’ll want to make sure these amounts are reasonable and not being used to avoid payroll taxes.
Tax Credits and Incentives
Depending on the nature of your business and its activities, your LLC may be eligible for various tax credits and incentives offered by not just federal, but also state and local governments.
For instance, some jurisdictions offer investment tax credits to encourage businesses to invest in certain areas or industries. These credits can offset a portion of the costs associated with purchasing equipment, expanding facilities, or conducting research and development.
Other examples include:
- Renewable energy tax credits
- Historic rehabilitation tax credits
- Job creation tax credits
- Enterprise zone credits
- Export incentives
Who Pays More Taxes: LLC or S Corp?
While pondering your business entity choices, you might’ve posed this question when deciding between an LLC or S corp. Unfortunately, there’s no simple answer, as it’ll depend on several factors.
In some cases, an S corp may offer tax advantages, particularly for owners who can minimize self-employment taxes by taking a reasonable salary and receiving the rest of their income as distributions.
Forming an LLC doesn’t necessarily give you better tax benefits, but if you’re a digital nomad, then it’s much better to have your LLC registered in a zero tax state.
Things to Note
While there are numerous tax benefits of an LLC, that doesn’t mean it’s all good news if you choose to form an LLC. Obviously, you’ll still have to pay taxes, such as self-employment ones. Many states impose annual fees, franchise taxes, and other administrative costs on LLCs too.
Not only do you pay self-employment taxes, but there’s potential for tax audits in this area as well. The IRS may scrutinize the distributions made by LLCs to their owners to ensure that they are reasonable and not used as LLC tax loopholes. If the IRS determines that an owner’s compensation is too low, they may reclassify them as salary, which subjects you to additional payroll taxes and penalties.
Also, depending on the state and the number of members in your LLC, you may face complex tax filing requirements. For example, multimember LLCs may be required to file additional tax forms, such as partnership tax returns (Form 1065), and issue Schedule K-1s to its members.
Enjoy LLC Tax Benefits Now
While there are some drawbacks, overall, you can enjoy many LLC tax benefits if you pick this business structure. These companies are technically tax-neutral, and you’d personally pay tax on the income from the LLC, based on the nature of the business and your personal tax residency.
So reap the tax advantages of an LLC, as well as its flexibility and limited liability protection. But also, be sure to carefully weigh the pros and cons and consult with tax professionals and legal advisors to determine the most suitable structure for your situation.
If you’ve decided that an LLC is right for you, then sign up with Business Anywhere today. We’ll set you up and be your registered agent too.
