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Many entrepreneurs opt to structure their small business as a limited liability company, or LLC. An LLC protects owners’ personal assets from lawsuits and some creditors. It also provides an easy-to-use business structure. In addition to these benefits, LLCs also offer numerous tax benefits. In this article, we take a look at the variety of tax benefits LLCs offer.
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How Limited Liability Companies Are Taxed
LLCs are taxed depending on how many owners they have and which tax status they choose. LLCs have the option of electing to be taxed as corporations if they wish, but must make that election with the IRS.
Single-Member LLCs
LLCs with one member are called disregarded entities by the IRS. The LLC’s profit is passed through to the owner’s tax return on Schedule C of Form 1040 and they pay tax on it themselves.
Partnerships
LLCs with at least two members are taxed as partnerships. The LLC must file Form 1065 Return of Partnership Income with the IRS. The IRS then reviews the 1065 to determine whether income has been reported correctly from the partners.
Partnerships must also provide a Schedule K-1 to the IRS, which breaks down each partner’s share of the business’s profits and losses. Then each partner reports this profit and loss information on their individual 1040 tax return.
Corporations
Any LLC that wishes to elect to be taxed as a corporation can make that election using IRS Form 8832, Entity Classification Election. The LLC can choose to be taxed as an S-corporation or a C-corporation.
Further Reading:Best Tax Software for Small Business
4 LLC Tax Benefits
Here are the top four tax advantages business owners are able to use when they form an LLC.
1. Tax Flexibility
LLCs are in the unique position of being able to choose if they will be taxed as a corporation or as a pass-through entity. When you create an LLC, you can choose to be taxed as a sole proprietor or partnership, or as a C-corporation or S-corporation. This flexibility provides the ability to choose the most beneficial tax approach for your company.
2. Avoiding Double Taxation
If you choose to be taxed as a sole proprietor or partnership, you avoid double taxation. Double taxation occurs when a corporation pays taxes on income and the shareholders or owners then also pay taxes on their own personal returns on the dividends they receive. By not electing to be taxed as a corporation, you avoid this issue.
3. QBI Deductions
With the Tax Cuts and Jobs Act of 2017, the Qualified Business Income (QBI) deduction went into place for LLCs, sole proprietorships, partnerships and S-corps. With this deduction, businesses can claim a tax deduction worth up to 20% of their qualified business income.
4. Business Deductions
LLCs can write off a number of expenses as business tax deductions to help lower the amount they owe on their income tax or the business owes as a corporation.
The process for claiming these deductions depends on how an LLC chooses to be classified and taxed. In the case of pass-through entities, deductions are claimed at the personal level. If taxes are paid as a corporation, deductions are claimed at the business level.
Common deductible business expenses include:
- Advertising
- Bank and interest fees
- Charitable donations
- Education
- Home office
- Health and disability insurance
- Internet expenses
- Startup costs
- Supplies
- Travel expenses
- Vehicle and mileage
Bottom Line
An LLC is the most common type of business entity, mainly due to the liability protection and tax benefits that it offers. LLCs have the flexibility to choose the tax status that will provide them with the most financial perks at tax time.
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Frequently Asked Questions (FAQs)
How is an LLC taxed?
LLCs are typically taxed with pass-through taxation. While multimember LLCs must file an informational tax return, single-member LLCs are not required to. In both cases, the profits or losses are passed through the business and reported on the owners’ tax returns. Any tax due is then paid by the owners at the individual tax level. LLCs have the option of choosing to be taxed as corporations if they make an election with the IRS.
What are the benefits of forming an LLC?
LLCs provide their owners with limited personal liability, in addition to a variety of tax benefits including avoiding double taxation, QBI deductions and business deductions.
How do business tax deductions work?
Business deductions refer to any business deduction allowed by the IRS for the purpose of lowering taxable income. To qualify for a deduction, an expense must be regarded as necessary and appropriate to the operation of a business.
What are the disadvantages of an LLC?
One disadvantage for small businesses is the cost. The associated fees for forming and registering can vary from state to state. Also, it isn’t as easy to transfer membership as corporate stock. Businesses with requirements for outside investments may also find other business structures better.
