Taxes LLC: Everything You Need to Know
The types of taxes LLC businesses face are a key reason why entrepreneurs choose a limited liability structure in the first place.3 min read
2. LLC Default Designation
3. Advantages of Corporate Taxation for LLCs
4. Disadvantages of Corporate Taxation for LLCs
The types of taxes LLC businesses face are a key reason why entrepreneurs choose a limited liability structure in the first place. Limited liability companies are the newest type of business entity. They are designed to protect owners from business-related debts and lawsuits, so even if your company faces debt collections, your personal property cannot be seized. For many business owners, however, choosing a business structure all boils down to taxes.
LLC Tax Advantages
Limited liability companies are incredibly flexible, especially when it comes to taxation. Unlike corporations, LLCs are “pass-through” tax entities, which means that the company itself doesn't pay taxes. Instead, all business income passes onto the owners, who are called members. Each member then claims profits and losses on their own personal tax returns.
Even though an LLCs taxes are set up differently than a corporation's, an LLC organizer can still choose to be taxed as a corporation. In fact, LLC rules are so flexible that you can elect to be taxed as a sole proprietorship, partnership, C corporation, or S corporation. Essentially, you decide which taxation option is best for your business.
By default, LLCs are considered disregarded entities because the IRS does not view them as taxable entities. A sole proprietorship is also a disregarded entity where all business income is treated as personal income. If you choose corporate taxation, your LLC is taxed at a lower corporate rate for the first $75,000 earned.
Either of these options comes with its own advantages, so you should consider how much money your business makes, how much you personally want to take, and how you plan to reinvest in the business.
Other benefits LLCs provide include:
- The ability to set up life insurance and retirement funds with increased contribution limits, helping you save more for the future
- The ability to lease personal assets to the business (for example, if you work out of a home office, you can lease the office from yourself and write off the lease as a business expense)
- The ability to deduct the costs of your LLC
LLC Default Designation
When you create an LLC, the IRS treats it like a sole proprietorship (single-member LLC) or partnership (multi-member LLC) for tax purposes. The IRS considers these tax situations default designations.
Since corporations are taxed differently than sole proprietorships and partnerships, you must elect to be taxed as a corporation if that's what you prefer.
By default, the IRS treats corporations as C corporations, meaning that the company pays corporate taxes on earnings in addition to the taxes its shareholders pay on personal income.
Many small businesses, including LLCs, choose to be classified as an S corporation for tax purposes. Unlike a C corporation, an S corporation does not pay corporate income tax. Instead, its shareholders report all business income on their personal tax forms. If you would like your LLC to be taxed as an S corporation, you should file IRS Form 8832. Once filed, you cannot change your company's tax designation for five years.
Advantages of Corporate Taxation for LLCs
In most cases, business owners choose the tax option that yields the lowest tax rate. Unfortunately, sole proprietorships and partnerships have higher tax rates than even the highest corporate tax rate. If your total taxable income is high, you may want to elect a corporate tax situation for your LLC.
The biggest benefit of being taxed as a corporation is that you don't have to include all the company's income on your individual tax return. In other words, if your LLC has a net profit of $75,000 per year, you must take that entire amount for your tax return. If you're taxed as a corporation, however, you can keep some of the profit in the business and not have to pay personal income tax on that profit.
Disadvantages of Corporate Taxation for LLCs
There are some drawbacks to corporate taxation. Double taxation is a major reason why business owners avoid corporate status because it means paying taxes twice: once on the company's income and again at the individual level. Still, the decreased tax rate may be significant enough to be a better option.
Make sure you consult with an accountant or tax professional before changing your tax status.
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