Understanding tax deductions for LLC, or limited liability company, can help business owners maximize savings while maintaining business profits.

What is an LLC?

An LLC is one of the newest business formation options. Business entities like partnerships and corporations have been around longer. A business owner can form an LLC by filing the articles of organization with the Secretary of State's office, or other applicable government agency within the state of operation. The LLC formation also requires payment of a filing fee.

How Does an LLC Pay Income Taxes?

Since LLCs are newer business formations, the IRS doesn't have a separate tax category for them. As a result, LLCs are taxed in the same categories as other business formations. When an LLC has a single owner, called a member, the default tax status is as a sole proprietorship. When an LLC has more than one member, the default tax status is as a partnership.

In both cases, the LLC isn't responsible for paying separate taxes. Instead, all business losses and profits are taxed on the member(s) personal tax return(s). This is referred to as pass-through taxation and is one of the benefits of forming an LLC over a corporation. However, single-member LLCs are classified as disregarded entities. This means that the business is not separate from its owner and is taxed as a sole proprietorship.

When filing taxes as the owner of a single-member LLC, fill out Schedule C on the personal tax return form with the information about profits and losses of the business. Any net income would be added as other income on your personal tax return. Multi-member LLCs are typically taxed similarly to single-member LLCs, although their taxation is as a partnership.

When preparing taxes for a multi-member LLC, the members must fill out IRS form 1065 with information provided on Schedule K-1. The LLC provides Schedule K-1 to each of the members and includes their shares of the business income and losses for reporting on individual tax returns. Members in both single-member and multi-member LLCs report business profits on their personal tax returns. Each LLC member's share of business profits is subject to self-employment taxes. However, the profits aren't taxed on a corporate level.

LLC members can choose taxation as a corporation for the business, which can help reduce costs associated with self-employment taxes. Profit distributions in a corporation are dividends, so they aren't subject to a self-employment tax. However, this election can come with complex consequences, so LLC members should consult with an experienced accountant before making the decision to be taxed as a corporation. For example, the profits of a corporation are subject to taxation at the corporate level as well as at the personal level for each shareholder, referred to as double taxation. Owners are classified as employees or shareholders.

When comparing a corporation to an LLC, consider the tax pros and cons. A C corporation, or general corporation, must pay the 21 percent federal tax rate on all business income. Starting after December 31, 2017, the 21 percent federal tax rate also applies to Personal Service Corporations' taxable income, including those owned by professionals and consultants.

Tax Advantages of the LLC

Some of the tax benefits of an LLC include:

  • Variable tax rates, which depend on the owner's total income. This means that an LLC owner could end up paying a lower tax rate than a corporation, even if the net income levels are high. For example, a corporation with $75,000 of taxable income would be subject to the federal tax rate of 34 percent, while an LLC with the same amount of taxable income could be subject to the personal tax rate of 25 percent. Other factors can play into the personal tax rate for the business owner as well.
  • Double taxation, which refers to taxation at the corporate and personal levels. The shareholders of a corporation must pay taxes on any dividends paid to them by the business.
  • Franchise tax, which is not required of LLCs in any state where a corporate franchise tax is applied to corporations. The amount of franchise tax varies between states.

A business that elects for taxation as a corporation can provide some financial benefits because the federal tax rate is limited to 21 percent.

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