Tax Deductions for LLC Owners: Everything You Need to Know
Tax deductions for LLC owners can help reduce tax requirements and help business owners keep more of the profits within the company.3 min read
Tax deductions for LLC owners can help reduce tax requirements and help business owners keep more of the profits within the company. However, it's important to understand that a limited liability company, or LLC, is not a separately taxable entity under the IRS.
How Does an LLC Pay Income Taxes?
Owners, also called members, of an LLC must elect for taxation as a corporation by filing either Federal Form 2553 for an S corporation or 8832 for a C corporation. If the form isn't filed, the LLC will be subject to default tax classifications.
An LLC with a single owner is subject to taxation as a sole proprietorship, by default. An LLC with more than one owner is subject to taxation as a partnership, by default. In both cases, the LLC doesn't have to pay taxes on profits. Instead, this pass-through entity has its profits and losses passed through the business to the owner(s), which are reported on their personal tax return forms each year.
The IRS treats single-member LLCs as “disregarded entities,” which means they are indistinguishable from their owners. Therefore, a single-member LLC is taxed as a sole proprietorship. When the owner of a single-member LLC reports the business profits and losses, they will use Schedule C, which is part of the tax return, to calculate the required tax. The owner will also add any net income to their other income on their personal tax return.
An LLC with multiple members is typically taxed as a partnership. In this case, the members prepare their tax returns on IRS Form 1065. Each individual owner will receive a Schedule K-1 from the LLC, which outlines the profits and losses, as well as the amount of tax each member is responsible to pay. The members use that Schedule K-1 on their personal tax returns. Both multi-member and single-member LLC owners will report all business profits on their personal tax returns.
Each share of the business profits is subject to self-employment tax. However, an LLC is not double-taxed as a corporation is, which means that the business itself doesn't have to pay tax on the profits.
One option for LLCs is electing for taxation as a corporation. In some businesses, this election can be financially beneficial since all distributions of the profits made to the owners are treated as dividends, which aren't subject to self-employment taxes. However, election for taxation as a corporation can come with complex consequences, so business owners should consult with an accountant before making the decision.
A C corporation, which is a general corporation that hasn't elected for taxation as an S corporation, or an LLC that has elected for taxation as a C corporation is responsible to pay the federal 21 percent tax rate on all of its taxable income. Additionally, the federal 21 percent tax rate applies to any taxable income of corporations owned by professionals or consultants, which are called Personal Service Corporations, as of December 31, 2017, and all subsequent tax years.
- The corporation business entity can offer reduced taxes for certain companies because the most it will be taxed is the 21 percent federal tax rate. This rate also applies to LLCs that have elected to be taxed as corporations.
- Corporations can retain as much as $250,000 without having to pay a higher tax rate on, or justify, the accumulated income.
- Any post-tax profits can be used by the corporation to grow the business or pay off business debt or be spent as working capital. This can be helpful and eliminate the need to take out business loans.
- The tax status as a C corporation can also help the owners average income over the years since net operating losses can carry over to future years and be carried back to up to the two previous years.
Tax Deductions for an LLC Business
An LLC qualifies for tax deductions and credits that other business types aren't eligible for, which gives this formation an advantage. Tax write-offs, also known as deductions, reduce the income that is subject to tax. Many of the expenses related to the operation and ownership of an LLC can be deducted as business expenses for federal taxes.
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