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

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.

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