LLCs are by far the most popular entity type amongst small businesses.
But what exactly are the benefits of an LLC? How does it protect your business? And more importantly, what are the tax benefits of choosing an LLC over another entity?
The answers to these questions may influence the entity structure that you choose for your business, and how much money you end up paying the IRS.
In this post, I’m going to explain all of the tax benefits related to LLCs.
Lastly, although I am a licensed CPA, the information in this post is solely for informational purposes only. It is not meant to take the place of legal and accounting advice specific to your business.
With that said, let’s talk about some LLCs.
First, let’s address the most important topic on everyone’s mind right now. The tax loopholes associated with LLCs.
LLC Tax Loopholes
I’m sure you’ve heard all of the stories about how the rich don’t pay taxes.
Or how politicians and alleged millionaires have tax schemes to not pay any taxes to the IRS.
And maybe you’ve heard that LLCs can help you evade taxes all together.
Well I’ve got news for you… it doesn’t.
LLCs is not a tax loophole. In fact, LLCs have nothing to do with your taxes, in general. LLCs are legal entities that protect you from personal liability in the event of a lawsuit, for example.
For tax purposes, your LLC is viewed as a sole proprietorship or partnership. In either case, it doesn’t necessarily mean that you’re evading taxes.
However, when stacked up against other entity types, there are ways that you can look at an LLC as a tax advantage or benefit.
So let’s dig into it.
Tax Benefits of LLC
Tax Benefit #1: Pass-through taxation
When it comes to entity taxation, there are two types of taxes that you need to be aware of:
- pass-through taxation
Pass-through taxation means that all money that your business receives is subject to taxation. Even if you did not pay yourself a dime from your business income, you will be taxed on it.
Double-taxation means that technically, you are taxed twice. First of all, your business is taxed on all income. And secondly, when you are paid, you are also taxed on income that you take out of your business.
With that being said, a major tax benefit of LLCs is that it is only taxed once with pass-through taxation.
Here’s an example of what I mean.
Let’s say you made $100,000 as a LLC. If your tax rate is 25%, then you would only pay $25,000.00 in taxes as a LLC.
However, on the other hand, let’s say you’re a C Corporation. If you made $100,000 as a C Corporation, your business would be taxed on that income first. If the corporate tax rate is 20%, then you would pay $20,000 in taxes.
But then, you have to pay taxes on what you pay yourself from your corporation. Let’s say, you pay yourself $50,000.00 in W-2 wages and this puts you in a 20% tax bracket. This would mean you would have to pay an additional $10,000.00 in taxes.
So in total, as a C Corporation you would pay $30,000 in taxes, whereas in a LLC, you would only pay $25,000 in taxes.
Now to be fair, this is an oversimplified example and there are additional things to consider like self-employment tax, for example. However, in general, this is an example of how someone could view a LLC as a tax benefit.
Tax Benefit #2: S-Corporation Election
Another tax benefit of LLCs is that you can elect to be taxed as an S-Corporation.
S-Corporations are unique in that you don’t have to pay self-employment taxes. However, you are supposed to pay yourself a reasonable salary, aka W-2 Wages, for the work that you perform.
Now the taxes you pay on your W-2 wages will typically be about the same as what you’d pay in self-employment taxes. However, if your business earns over a reasonable salary for your own work, then electing to file as a S-Corporation may be worth considering.
Again, this is simplified information, but if you want to weigh the pros and cons of this, you can contact us to create a custom tax plan for you.
Tax Benefit #3: Tax Write-Offs
The next tax benefit of an LLC are tax write-offs.
This is a major benefit for self-employed individuals who may not be writing off things related to their business like your home office expense, business travel, and other related business expenses.
A LLC is typically considered separate from you as an individual.
Which means that your business finances should be separate from individual finances, making it easier for you to keep track of your business expenses in order to deduct it from your taxes.
For example, if you have a business bank account, you can sync your financial information with a bookkeeping platform like QuickBooks, for example. Then, you can categorize all of your business transactions so you can easily start deducting eligible expenses from your tax return.
Tax Benefit #4: Pass-through Tax Deductions
Now, I’m about to contradict myself but I’ll explain why.
GENERALLY, there is no difference in tax write-offs for LLCs vs another entity type.
However, LLCs are eligible for the 20% Pass-through Tax Deduction that was passed through the Jobs Act.
Pass-through owners who qualify can deduct up to 20% of their taxable income from their taxes.
So for example, if you were preparing to file a tax return that would report $100,000 in income, then this deduction would reduce your taxable income to $80,000. If applicable, the $20,000 in savings would save you thousands of dollars on your business tax return.
Now, there are a few rules and regulations that may disqualify you from receiving this tax deduction. However, if you are eligible for it, it could turn into some good tax savings.
Tax Benefit #5: LLCs are Easy to Set-Up
One of my favorite things about LLCs is that it is fairly easy to set-up, which ultimately makes filing your taxes much easier and less stressful than other entity types.
You don’t have to worry about dividing up stuff like common stock and preferred stock. And there is less record-keeping required for setting up your LLC.
Ultimately, there is less compliance required for setting up LLCs.
So if you don’t have a lot of things going on in your business, starting with a LLC might be a great option for you.
Ok, so those are the major tax benefits of a LLC. Now, let’s recap today’s episode.
Today, we explained the biggest tax advantages of a LLC.
First, we debunked the myth that LLCs in of itself is a tax loophole. It’s not. An LLC is simply a legal entity that comes with some protections for you as a business owner.
Then, we went into the major tax benefits of a LLC. Those tax benefits were:
- Pass-through taxation
- S-Corp Election
- Business Tax Write-Offs
- Pass-through Tax Deductions
- Ease of Setting up