LLC taxes info & guide
When running a small business, it’s helpful to form a legal entity. In doing so, you create additional layers of legal protection and distinct tax advantages. And out of all the different types of business classifications, the Limited Liability Company (LLC) is one of the simplest, most common options.
What is an LLC?
When first starting, it’s common for entrepreneurs to operate as sole proprietors. But as soon as the business starts growing, it quickly becomes apparent that this isn’t the best structure. An LLC, the most natural choice for small business owners, protects you against lawsuits and other costly legal action. It can also reduce paperwork and make your business seem more credible in the marketplace.
“For most small businesses, a limited liability company offers the right mix of personal asset protection and simplicity,” TRUiC explains. “Unlike sole proprietorships and general partnerships, LLCs can protect your assets if your business is subject to legal action. Unlike corporations, LLCs are relatively easy to form and maintain and are not subject to double taxation.”One of the more unique aspects of an LLC is that you can choose how you want to structure the ownership. There are two basic options:
This option is ideal when you’re the only person in the business or want complete control over all operations and decisions. The LLC label simply establishes the business as its legal entity (independent of you, the owner.)
If there are two or more business owners, a multi-member LLC allows for shared control of the company. You can have an unlimited number of LLC members and clearly outline how each individual's profits and losses are distributed. While a single-member LLC is relatively straightforward, multi-member LLCs must decide how they want to be managed.
The first option is to be member-managed, which means all members actively participate in the work of the business. In this case, the company needs majority approval from members to enter into contracts, secure loans, or make other important decisions. The second option is to be a manager-managed LLC. Under this structure, members elect a manager and give this individual the authority to make decisions about the business's day-to-day operations.
The tax benefits of an LLC
While an LLC offers good legal protection for business owners, it’s the tax advantages that are most desirable. Let’s explore this topic in more detail:
Pass-through taxation is the defining characteristic of the LLC. It’s the concept that you’ll hear discussed the most – and rightly so. It describes how LLC earnings can be passed through to the owner(s) without first having to pay any corporate federal income taxes. In other words, LLC businesses don’t pay any taxes themselves.
All earnings are passed on to the owners, who pay taxes at their tax rates. The pass-through feature is one major way the LLC differs from the standard C corporation. Whereas C corp owners are subject to double taxation – once as a business and once as an individual – the LLC owner only pays taxes one time.
Another benefit of the LLC is that the IRS allows business owners to choose how the business is taxed. You can be taxed as a sole proprietor, partnership, C corporation, or S corporation (with a few exceptions). Here’s a breakdown:
LLC as a sole proprietorship
If it’s just you, you can set up your LLC as a sole proprietorship. You simply file a Form 1040 individual tax form and a Schedule C to report the business profit or loss from the LLC. This is the simplest option, but it also caps your tax benefits.
LLC as a C corporation
This choice is excellent under certain circumstances. It allows your LLC to be taxed as a C corporation, which means you must file a Form 1120 corporation tax return. The corporation pays taxes on all profits, while members report the income passed through on their returns. Taxes don’t need to be paid on income that doesn’t pass through to members.
LLC as an S corporation
When you set your LLC up to file as an S corporation, you file a Form 1120S. This means you don’t pay any corporate taxes on the income earned. Instead, shareholders report their portion of the income on their tax returns.
LLC as a partnership
For multi-member LLCs, you can file as a partnership. Under this setup, each LLC owner pays taxes according to the share of profits/losses they’re responsible for. This information is reported on Form 1040 and Schedule K-1. Don’t let all of these options confuse you. In most cases, certain restrictions mean you can only choose from a couple of them anyway. Take your time, do your due diligence, and don’t let it stress you. Once you wrap your mind around the issue, it’ll make perfect sense.
How to lower your business taxes
Forming an LLC is a great way to avoid double taxation and enjoy optimal flexibility. Here are a few other ways your small business can lower taxes and maximize profits:
Make intelligent tax elections
Be smart about how you deduct expenses and investments. While you can sometimes deduct the total cost of an item in the current tax year, it might make more sense to depreciate it over a few years (if you expect your income to be higher).
Use an accountable
If you have employees and reimburse them for travel costs, lodging, food, etc., you can save on taxes by using an accountable plan. Under this type of plan, you can deduct the expenses without having to report the reimbursements as employee income. This saves everyone money.
There are limitations on certain deductions and credits that prevent businesses from using them entirely in the current tax year. However, you may be permitted to carry them over into future years and reduce taxable income. Examples include charitable contribution deductions, capital losses, general business credits, and net operating losses. If you use carryovers, make sure you keep a detailed log, so you don’t forget to use them in future years. (Otherwise, you end up costing your business money.)
Fringe employee benefits plans
Any time you give your employees additional wages, you trigger more employment tax costs for the business. However, if you can turn these wages into fringe benefits, the taxes disappear. Examples of tax-exempt benefits include employer-sponsored health insurance, group life insurance, transportation, and educational assistance. A CPA or tax professional can always look at your specific situation and walk you through some of the particular ways to save money, bolster profits, and avoid paying more to the IRS than necessary.
When you’re a business owner, there are tons of different responsibilities and distractions vying for your attention. Taxes are the last thing on your mind. Yet, if you want to run a profitable business, you have to pay attention to this all-important element of your organization. At Taxfyle, we take care of taxes – from preparation to submission – so that you can focus on all of the other duties that come across your desk. Simply fill out a basic questionnaire, and we’ll get you connected with the proper tax professional for the job.