How Do LLC Tax Benefits Work? A Guide for Small Businesses

How LLC Tax Benefits Work

Here’s a look at the LLC tax rate, which can be lower for small businesses in some cases.

Taxation is one element to consider when choosing a business structure for your company. One unique aspect of Limited Liability Companies (LLCs) is your ability to decide how they will be taxed. That choice determines which LLC tax benefits you get – and how you will file your taxes. Either way, you gain more tax advantages with an LLC than you will if you choose a sole proprietorship. This overview reviews the tax advantages of LLCs and how you might be able to take advantage of them.

How Is an LLC Taxed?

Generally, the IRS does not tax LLCs directly. Unlike a corporation, an LLC does not need its own tax return. Its profits are disbursed to its members, who report them as self-employment income. This setup is known as a “pass-through entity,” meaning business income is treated as members’ personal income. A pass-through entity is the LLC default tax status.

The LLC tax rate is then based on the member’s individual income tax rate. So, tax brackets for LLCs depend on the member’s filing status and combined income.

However, the pass-through entity approach is not the only way to tax an LLC. One of the advantages of LLCs is flexibility with tax classification.

Tax Classification for LLC Structures

Tax classification is one of your LLC tax benefits. Your LLC is not limited to pass-through taxation. You and any other members charged with governing your LLC can elect to tax the LLC as an S corporation. This election classifies the LLC as a corporation for tax purposes and requires the LLC to file a return as an entity. You can change the tax classification by completing Form 8832, Entity Classification Election.

Mainly, the S corporation classification allows you to save on Social Security and Medicare taxes since members and managers gain employee status. The members and managers also avoid paying self-employment tax. However, it introduces the double taxation issue; the LLC must pay a corporate tax rate, and the members must pay personal income taxes on their LLC income.

If you choose pass-through taxation, your return requires a Schedule C for single-member LLCs or a 1065 Partnership Return for multiple-member LLCs. In some cases, going the pass-through route produces fewer taxes than if you file as an S corporation and pay corporate income tax rates. Since every business is different, you can’t know which route is best for you unless you audit your financial records.

Tax Advantages of LLCs

LLC tax benefits are most evident if you switch from a sole proprietorship to an LLC. Here are the advantages business owners discover when they form an LLC.

Flexibility

LLCs are different; you can treat LLC profits as self-employment income and file a personal income tax return. Or you can elect to have your LLC treated as an S corporation for income tax purposes and enjoy corporate tax benefits. When you choose a sole proprietorship or a corporation, you don’t have options regarding how you are taxed.

Corporate Tax Deductions

If they choose S corporation status, LLC tax benefits include the same corporate tax deductions. Popular deductions include:

  • Insurance: Premiums paid for health or disability insurance are deductible. These policies can be available to members, managers, executives or employees. If the LLC pays for the premiums, it can deduct that cost.
  • Vehicles: Vehicle deductions apply to company fleet vehicles and reimbursements to employees when they use those vehicles. You can also receive the deduction if you lease vehicles for company purposes. The requirement is the vehicle, and any expenses tied to it must be for business use only.
  • Home office: LLCs are an excellent entity for at-home businesses, and now the IRS allows reimbursement for those expenses. However, there are requirements. For example, the home office must be reserved for business use, including administration and management. Reimbursable home office expenses include maintenance, cleaning, telephone, utilities and insurance. The IRS determines the deduction by the square footage in your home used by the LLC.

Other relevant business expenses may also be deductible. Since excessive deductions lead to audits, you must discuss deductions with your tax professional before finalizing them in a tax return.

Pass-Through Deduction

The Tax Cuts and Jobs Act (TCJA) added the latest LLC tax benefits. This act allows LLC members to deduct up to 20% of their business income before calculating tax. If you don’t choose S corporation tax status for your LLC, members can often avoid higher self-employment and income taxes with this deduction. It’s just another benefit to weigh when deciding between S corporation and pass-through taxation.

Legal Disclaimer: This article contains general legal information but does not constitute professional legal advice for your particular situation and should not be interpreted as creating an attorney-client relationship. If you have legal questions, you should seek the advice of an attorney licensed in your jurisdiction.

Top Tax Advantages of Buying a Home

tax credits

Save money with these deductions and credits.

There are plenty of perks to owning your own home rather than renting. You can knock down walls if you want to, you can install a professional home theater system, or you can paint the walls with purple polka dots if you like. But there are other benefits—the financial kind.

If you rented in the past, all of your money went to a landlord, and none of it came back to you as a tax deduction. That changes if you’re a homeowner.

Whether you buy a mobile home, townhouse, condominium, cooperative apartment, or single-family home, several tax breaks can save you money at tax time.

The downside is that your taxes will get more complicated. You can’t just plug your W-2 information into Form 1040 and finish your taxes in 10 minutes. As a homeowner, you can take advantage of itemizing, which can save you a lot of money.

KEY TAKEAWAYS

    • The Internal Revenue Service (IRS) provides several tax breaks to make homeownership more affordable.
    • Common tax deductions include those for mortgage interest, mortgage points, and private mortgage insurance (PMI).
    • To claim the deductions, you have to itemize your taxes rather than taking the standard deduction.
    • Tax credits are available for qualified first-time homebuyers and homeowners who invest in energy improvements like solar panels and energy-efficient windows.1

The standard deduction for the 2024 tax year is $29,200 for couples filing jointly, and $1,460 for singles. That’s up from $27,700 for couples and $13,850 for singles in 2023.2 You might do a quick calculation of your deductions and see if the standard deduction saves you more.

Tax Credits vs. Tax Deductions

In the tax world, there are deductions, and there are credits. Credits are better.

    • A credit is directly subtracted from your tax bill. If you get a $1,000 tax credit, your total tax amount due will decrease by $1,000.
    • A tax deduction reduces your adjusted gross income (AGI), which reduces the amount of taxes you owe. For example, if you’re in the 24% tax bracket, your tax liability will be reduced by 24% of the total claimed deduction. If you claim a $1,000 deduction, your tax liability will drop by $240 ($1,000 × 24%).

Tax Deductions for Homeowners

Most of the favorable tax treatment that comes from owning a home is in the form of deductions. Here are the most common deductions:

Mortgage Interest Deduction

You can deduct your home mortgage interest on the first $750,000 ($375,000 if married filing separately) of mortgage debt. The old limit—$1 million ($500,000 if married filing separately)—applies if you bought your home before Dec. 16, 2017.3

You can’t deduct home mortgage interest unless you itemize deductions on Schedule A Form 1040 or 1040-SR. You can deduct mortgage interest on a second home as long as the mortgage satisfies the same requirements for deductible interest as on your primary residence.4

In January, after the end of the tax year, your lender will send you Internal Revenue Service (IRS) Form 1098, detailing the amount of interest that you paid in the previous year.5

If you just bought your home, be sure to include any interest that you paid as part of your closing. Lenders will include interest for the partial first month of your mortgage as part of your closing. You can find it on the settlement sheet. Ask your lender or mortgage broker to point this out to you. If it’s not included on your 1098, add this to your total mortgage interest when doing your taxes.

Mortgage Points Deduction

You may have paid mortgage points to your lender as part of a new loan or refinancing. Each point that you buy generally costs 1% of the total loan and lowers your interest rate by 0.25%. For example, if you paid $300,000 for your home, each point would equal $3,000 ($300,000 × 1%).

With a 4% interest rate, for instance, that one point would lower the rate to 3.75% for the life of the loan. As long as you actually gave the lender money for these discount points, you get a deduction.

Like the mortgage interest deduction, discount points are deductible on the first $750,000 of debt.

If you refinanced your loan or took out a home equity line of credit (HELOC), you receive a deduction for points over the life of the loan. Each time you make a mortgage payment, a small percentage of the points is built into the loan. You can deduct that amount for each month that you made payments. So, if $5 of the payment was for points, and you made a year’s worth of payments, your deductible amount would be $60.40

Your lender will send you Form 1098, detailing how much you paid in mortgage interest and mortgage points. Using that information, you can claim the deduction on Schedule A of Form 1040 or 1040-SR.67

Private Mortgage Insurance (PMI)

Lenders charge private mortgage insurance (PMI) to borrowers who put down less than 20% on a conventional loan.8 PMI usually costs $30 to $70 a month for each $100,000 borrowed. Like other types of mortgage insurance, PMI protects the lender (not you) if you stop making mortgage payments.

Depending on your income and when you bought your home, you might be able to deduct your PMI payments.9

Mortgage insurance premiums are no longer deductible.10

State and Local Tax (SALT) Deduction

The state and local tax (SALT) deduction lets you deduct certain taxes paid to state and local governments if you itemize on your federal return.

The $10,000 cap applies whether you are single or married filing jointly and drops to $5,000 if you’re married filing separately.11 The deduction limit relates to the combined total deduction of state income, local income, sales, and property taxes.

You must itemize your deductions to claim the mortgage interest deduction, mortgage points deduction, and SALT deduction. You can’t claim these deductions if you take the standard deduction when filing your tax return.

If you pay your property taxes through a lender escrow account, you’ll find the amount on your 1098 form.5

Otherwise, you can look at your personal records in the form of a check or automatic transfer if you pay directly to your municipality.

Be sure to include payments that you made to the seller for any prepaid real estate taxes (you can find them on your settlement sheet).

State and local income taxes withheld from your paycheck appear on your W-2 form, which your employer(s) should send by the end of January following the tax year.1213 If you elect to deduct state and local sales taxes instead of income taxes (you can’t deduct both), you can use your actual expenses or the optional sales tax tables found in Schedule A (Form 1040).1415

Home Sale Exclusion

Chances are you won’t have to pay taxes on most of the profit that you make when you sell your home, thanks to the home sale exclusion.

If you’ve owned and lived in the home for at least two of the five years before the sale, you won’t pay taxes on the first $250,000 of profit (that is, the capital gain). The number doubles to $500,000 if you’re married filing jointly. However, at least one spouse must meet the ownership requirement, and both spouses must meet the residency requirement that they have lived in the home for two out of the previous five years.16

You might be able to meet part of the residency requirement if you had to sell your home early due to a divorce, a job change, or some other reason.

If you have a taxable gain on the sale of your main home that is greater than the exclusion, report the entire gain on Form 8949: Sales and Other Dispositions of Capital Assets.17

Depending on how long you owned the home, any gains will be taxed at either the short-term or long-term capital gains rate:

    • Short-term capital gains tax rates apply if you owned the home for less than a year. These gains are taxed at your ordinary income tax rate, which will be somewhere between 10% and 37% depending on your income for the year. 18
    • Long-term capital gains tax rates apply if you owned the home for more than a year. The rate is 0%, 15%, or 20%, depending on your filing status and income.19

Tax Credits

You might be eligible for a mortgage credit if you were issued a qualified mortgage credit certificate by a state or local governmental unit or agency under a qualified mortgage credit certificate program.20

Also, check energy.gov to find out whether your state offers tax credits, rebates, and other incentives for energy-efficient improvements to your home.

Which Expenses Can I Itemize?

Homeowners can generally deduct home mortgage interest, home equity loan or home equity line of credit (HELOC) interest, mortgage points, private mortgage insurance (PMI), and state and local tax (SALT) deductions.

Whether or not you’re a homeowner, you may be able to deduct charitable donations, casualty and theft losses, some gambling losses, unreimbursed medical and dental expenses, and long-term care premiums.

You itemize your deductions on Schedule A Form 1040.

Who Should Itemize Deductions?

All taxpayers have the option of taking the standard deduction or itemizing deductions. You can take whichever option saves you the most.

The standard deduction for the 2024 tax year is $29,200 for couples filing jointly and $1,460 for singles. For the 2023 tax year, it’s $27,700 for couples and $13,850 for singles.2

Note that these numbers are double the standard deduction amounts available before 2018 when the tax code got an overhaul. You might do a quick calculation of your deductions and see if the standard deduction saves you more.

What Are the Standard Deduction Amounts for 2023?

For the 2023 tax year, the standard deduction is $13,850 for single people or married couples filing separately, $20,800 for heads of household, and $27,700 for married filing jointly couples.

For the 2024 tax year, the deduction is $14,600 for single people or married couples filing separately, $21,900 for heads of household, and $29,200 for couples who are married filing jointly.18

The Bottom Line

Let’s keep this in perspective: If you’re in the 24% tax bracket, you’re still paying nearly 75% of your mortgage interest without any deductions.

Don’t fall into the trap of thinking that paying interest is beneficial because it reduces your taxes. In many cases, paying off your home as quickly as possible is the best financial move, particularly with the much larger standard deduction now in effect.

Source: investopedia.com ~ By: By TIM PARKER ~ Image: Canva Pro

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