Tax Benefits of LLC: Everything You Need to Know
One of the primary tax benefits of an LLC is that the business entity is not responsible for taxes on profits. 8 min read
2. The Different Types of Tax Deductions That Are Allowed for LLCs and Corporations
3. Understanding Insurance Basics for Limited Liability Companies and Corporations
4. Understanding the Relationship between Retirement Plans and LLCs
5. Limited Liability Companies and Employees Who are Minors
6. How LLCs and Corporations Deduct Meals
7. Deductions for Business-Related Educational Programs
8. Dues Can Be Deducted, Too
9. Business Trips and Deductions
10. What Self-Employed Professionals Need to Know About Registering as an LLC or Corporation
11. Some Other Financial Situations to Consider
Tax Benefits of an LLC
One of the primary tax benefits of an LLC is that the business entity is not responsible for taxes on profits. The tax rate for the LLC depends primarily on how much income the owner of the LLC receives. There is also greater taxation flexibility for LLCs, and the LLC can choose how it is going to be taxed. Additionally, LLCs are not subject to double taxation, whereas corporations are. Other benefits include bigger contribution limits and leasing assets. The owner or owners of an LLC can lease any of their personal assets to the business entity.
Other things to keep in mind about the limited liability structure is that all profits coming through the business entity are subject to tax, and there is no exemption from property taxes. While some states provide corporations with exemption from property taxes, LLCs are still subject to them. Lastly, owners of LLCs are still required to pay self-employment taxes in order to cover Medicare and Social Security. Owners of corporations pay half the required self-employment tax because they act as employees (the remainder of their self-employment tax is paid by the corporation).
Almost all of the stockholders of a corporation are responsible for controlling this type of legal structure. Every year, a corporation has to file a U.S. Corporation Income Tax Return and have an Employer Identification Number (EIN) to complete this task.
The Different Types of Tax Deductions That Are Allowed for LLCs and Corporations
- Charitable Deductions: Most legal experts would advise corporate owners to make personal charitable contributions instead of charitable donations through the corporation. This is because corporate entities are only permitted to deduct charitable contributions of up to 10 percent of the corporation’s taxable income.
- Health Insurance: Any C-corporation or LLC that is taxable is permitted to deduct the employed owner’s health insurance premiums. Along with the owner’s health insurance premiums, the health insurance premiums of the owner’s spouse and dependents can also be deducted. The premium’s cost cannot be taxed to the employee owner. Depending on the insurance company and their specific regulations, health insurance may not always be offered to employees. And if health insurance is offered, it might just be single coverage.
- Disability Insurance: Disability insurance can be bought for several employees or executives of either a C-corporation or a taxable LLC. The premium of the disability insurance can be deducted, and the cost will not have to be taxed to the executives or employees. However, the downside to this is that, once benefits are received by any disabled employee or executive, those benefits will be subject to taxation. This taxation can be avoided if the executives or the employees buy the insurance and pay for the disability insurance premiums. Once the disability contract is up, the executive or employees can be reimbursed for the premium and the C-corporation or taxable LLC can get a deduction on that reimbursement.
- Business Vehicle: An executive or employee can be reimbursed for vehicle use by the C-corporation or taxable LLC based on the mileage rate allowed by the IRS. The vehicle must be for business use only and owned by either the employee or executive. Alternatively, the C-corporation or taxable LLC could buy or lease a vehicle for which it would partly be used for personal reasons (like driving to and from the office). This has to be included in the employee or executive’s Form W-2.
- Home Office: If owners or employees of a corporation or taxable LLC have a home office, the Internal Revenue Code now allows for the reimbursement of that expense. However, the home office must be used on a routine basis, and it must be used solely for all tasks related to business administration and management (or for the purpose of storing supplies, inventory, or records). The home office expense can be reimbursed either every month or every year. This expense is not a part of the employee’s income, and it is deducted by the taxable LLC or the corporation. Other items you can include in the home office expense are maintenance, cleaning, telephone, utilities, and homeowner’s insurance. The percentage of the home office space that is a part of the house is used to calculate the reimbursement. In the first year of a home being purchased, Section 179 of the Internal Revenue Code allows a total deduction of $25,000 or less personal property expenses when used for business purposes. Things that qualify as personal property include computer software, computers, and furniture used in the home office.
Understanding Insurance Basics for Limited Liability Companies and Corporations
Although regulations regarding workers’ compensation insurance vary in each state, you want to confirm whether or not your LLC is mandated by law to provide your employees with this type of insurance. Some states such as Texas do not require workers’ compensation insurance at all, whereas in California it is required. In many states, it is common for this type of insurance to kick in once a business employs a certain number of people (like four or more). One of the biggest benefits of investing in workers’ compensation insurance is that once one of your employees uses it for a work-related injury or illness, they will not be able to sue you later on in the future. In general, having general liability insurance is also a wise investment even when it is not a legal requirement.
Additionally, individual owners of the LLC or corporate entity might want to think about having their own umbrella liability insurance policy. Coverage of a minimum of $1 million for the owners’ home and vehicle policies is strongly recommended. Foregoing insurance means that the premiums can by deducted by the LLC or corporation.
Understanding the Relationship between Retirement Plans and LLCs
Contributions to certain retirement plans can be deducted by the taxable LLC or corporation. There are many qualified retirement plans to choose from, with varying limits on deductions that could be implemented. Any contributions to retirement plans can build up without being taxed. Only after the contributions have been distributed to employees will they be asked to provide income tax. Distribution or retirement savings could be offered at retirement or because of a disability or death. In the event of an employee leaving your company and taking a new job, the employees can put their income-tax-free interest into a rollover IRA account or into their new employer’s plan.
Limited Liability Companies and Employees Who are Minors
If the LLC business owner employs their children and those children are minors, they can be compensated for working summer vacations and after school. This is essentially considered a tax-free allowance. A minor child can earn income up to $6,200 before they would need to file their own tax return. When a child is employed by the taxable LLC or corporation, contributions to Social Security still need to be made. However, to be exempt from withholding tax, Form W4E has to be filed. Additionally, a minor is permitted to add up to $5,500 of any income they make into their IRA or their Roth IRA account. If you plan to employ minors at your company, you will want to research both local and state regulations regarding their work hours.
How LLCs and Corporations Deduct Meals
Any meals that are eaten during professional development or business entertainment (such as dining with a client) can be deducted up to 50 percent by the taxable LLC or corporation. Meals consumed with employees can be deducted 100 percent.
Deductions for Business-Related Educational Programs
Educational costs incurred by employees who seek to enhance their professional skills can be deducted up to $5,250. Educational expense reimbursements are not a part of an employee’s income.
Dues Can Be Deducted, Too
Any dues that a taxable LLC or corporation pays in order to be a member of a professional organization can be deducted. Additionally, any magazine or newspaper subscriptions an employee or executive has that are relevant to the business can be deducted. These costs are not a part of employee income.
Business Trips and Deductions
When an employee or executive of the taxable LLC or corporation incurs expenses like program fees, meals, lodging, and transportation to attend a business function such as a trade show, convention, or seminar, a deduction can be applied. Even if there will be more than one employee or executive attending a business-related function, this deduction can still be used. Reimbursement for these business expenses is not a part of employee income.
What Self-Employed Professionals Need to Know About Registering as an LLC or Corporation
If a someone like a consultant or any other independent professional decides to form his or her own LLC or corporation so that they can receive their income through that legal structure, an agreement needs to be formed explicitly stating that the LLC or corporation exists as an independent contractor. Through that independent contractor, clients agree to receive the consultation services. All income is paid directly to the consultant, and this consultant is not subject to employment taxes or to withholding. In many cases, a retired executive may go on to start an LLC or corporation so that they can consult past employers or clients. By doing this, they can receive the tax benefits of an LLC or corporation.
Some Other Financial Situations to Consider
A taxable LLC or a C-corporation can choose the fiscal year for all individual income taxes in the Dec. 31 year. All income that comes through the taxable LLC or corporation before the Dec. 31 date is able to be deducted (so long as that income counts as compensation after Dec. 31). However, this has to be done before the taxable LLC or corporation’s fiscal year is up.
You can elect a fiscal year, and it will be included on the company’s tax return. This has to be filed in the two and half month period after their first fiscal year ends.
Everything that a C-corporation or taxable LLC earns throughout the year could be lent out to owners or members of the C-corporation or taxable LLC. Up to $10,000 without interest can be lent to each owner of the corporation or LLC. If and when a loan exceeds the $10,000 limit, minimum interest kicks in (such as 6 percent).
If the owner or member of the limited liability company who is borrowing the money has a mortgage on his or her house at the time of accepting the loan, any interest accrued can be a home equity loan deduction (on the first $10,000).
If you need additional capital to start your taxable LLC or C-corporation, you can offer loans to the legal entity after other startup capital was received. In states including Nevada, Florida, and Delaware, a limited liability company or a corporation does not need to meet any capital contribution minimums in order to receive loans.
This is an appealing practice because a loan can be reimbursed out of a taxable LLC or corporation’s earnings at a lower tax rate. This helps ensure that funding is not stuck in the limited liability company or C-corporation until the legal entity is liquidated.
The Internal Revenue Service will consider a repaid loan as a dividend only if it has not exceeded five to 10 times the initial amount of startup capital contribution made by the owner or owners.
If you need want to learn more about the tax benefits of a limited liability company or have any other questions pertaining to LLCs, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.