The Tax Advantages of LLCs for Small Businesses
From taxes to how much of your personal assets are at risk, you'll want to pick a business structure that gives you the right balance of legal protections and benefits. That’s where a Limited Liability Corporation (LLC) comes in.
Unlike a sole proprietorship or partnership, an LLC gives business owners personal liability protections for any actions of the business. Generally, LLCs provide certain tax benefits and greater flexibility, and they also come with a lot less paperwork than C corporations and S corporations.
When it comes to taxes and saving your business money, is an LLC the right structure for small business owners like you? Let's dig in to weigh the pros and cons.
The Pros of Forming an LLC
1. Pass-Through Taxation
One of the biggest tax advantages of a limited liability company is the ability to avoid double taxation. The Internal Revenue Service (IRS) considers LLCs as “pass-through entities.” Unlike C-Corporations, LLC owners don’t have to pay corporate federal income taxes. Instead, owners have the option to report their share of profits and losses on their personal income tax return.
Known as "pass-through taxation," this prevents your business from being taxed twice, once at the corporate level, and again at the personal level.
2. Choosing How You’re Taxed
One of the clearest advantages of having an LLC is the option to elect how you’re taxed. As an LLC, you can choose to be taxed as a sole proprietor, partnership, c-corporation, or s-corporation.
If you choose to be taxed as a sole proprietor or s-corp, your LLC’s income will be treated as your personal income on your tax returns, meaning you’ll only be taxed once.
If you choose to be taxed as a corporation, your income from your LLC will be taxed twice— once on at the personal level and again at the corporate level, but you’ll be taxed at a lower corporate tax rate for the first $75,000 of income.
Both of these approaches can have big advantages, depending on how much income you personally want to take and how much you plan to reinvest in your business.
3. Deducting Business Expenses
Costs add up quickly when you're growing a small business. Luckily, the IRS allows you to write off many of those expenses when you file income taxes each year.
According to the federal tax code, the owner of an LLC can deduct startup expenses incurred by the business no matter how the LLC is setup. Startup costs are defined as deductible expenses incurred by an LLC owner in the very early stages of business development. This includes things like advertising campaigns, training new hires, travel expenses—basically anything that helps get your business off the ground before you make your first sale.
Once your business is officially open, you can continue to write off ongoing operational costs for business expenses like cell phones, internet, business meals, accounting fees, and office space.
Before you’re convinced a limited liability company is the right business entity for your small business, consider these potential disadvantages.
Things to Consider
Compared to a sole proprietorship or partnership, an LLC can be a little more expensive to operate.
Additionally, members of an LLC are considered self-employed and must pay self-employment tax contributions towards Medicare and Social Security, though you can deduct the employer portion of your self-employment tax on your tax returns.
Ready to Reap the Tax Benefits of an LLC?
Forming an LLC is relatively simple. In most cases, you’ll start by choosing your business name, ensuring it’s available, and that doesn’t infringe on any existing trademarks.
You’ll then need to file articles of organization to your Secretary of State office, complete a fill-in-the-blank form, and pay a filing fee. For better financial and legal protection, owners should create an LLC operating agreement even in states that don’t require one.
Keep in mind that these are general guidelines. Since establishing an LLC differs by state, find your state agency and confirm whether there are additional requirements for your new business.
If you’re considering how to organize your business, an LLC may be a good option from a tax perspective.
LLCs offer business owners simplicity and flexibility in choosing how their business income will be taxed at the federal level compared to a C corporation. Plus, you won’t have to worry about personal liability and losing your personal assets for the sake of the business.
That said, think about your goals and decide if a limited liability company feels right for your company. It doesn’t have to be a one-time, written in stone decision. Since your needs will likely change over time, you can always restructure your company down the road, and LLCs are particularly easy to restructure.
As you do more research, check on state laws and consult with your accountant. While you're at it, make sure to also visit your small business continuity plan so you can be best prepared for whatever your business throws at you.