LLC Tax Benefits: A Small Business Guide

  • October 26, 2022

A limited liability company (LLC) is a type of business structure that combines some of the benefits of other kinds of businesses. An LLC is the most common type of business — 35% of all businesses use this structure. And it’s easy to see why. Structuring your business as an LLC comes with serious tax benefits, allowing self-employed people to take home more of their earnings or reinvest them in the business.

Read More: Lessons Learned About Tax Prep as an Entrepreneur

What Are the Tax Benefits of an LLC?

Because they can choose to file taxes as any business type, LLCs come with some of the most significant tax benefits of any business structure. These benefits can help business owners to simplify their tax process and take home more of their hard-earned profits.

Pass-through taxation

The first big benefit of structuring your business as an LLC is that you avoid the double taxation that corporations are generally subject to.

Corporations first must pay corporate taxes on their earnings at a rate of 21%. Then, corporate owners and shareholders must pay taxes on the share of the profits they take home in dividends. Ultimately, the money is taxed twice.

But that’s not the case with LLCs. Instead, the profits pass through directly to the owners without having to be taxed at the business level. The earnings are subject to taxes just once, meaning a greater percentage is left in the end.

Tax flexibility

LLCs are the most flexible type of business because they can really elect to be taxed as any other type of business structure. By default, LLCs are taxed as sole proprietorships (or partnerships, if the LLC has more than one owner). With this type of taxation, the profits simply pass through to the owner(s), who pays income and self-employment taxes on the money.

But LLC owners can also choose to pay taxes as either a C corporation or an S corporation. An LLC might choose to do this if they want to keep all profits in the business and their personal income tax rate is higher than the corporate rate of 21%. Because the owner, in this case, isn’t taking their share of the profits as dividends, they only pay taxes on the money once.

A company might choose to pay taxes as an S corporation to save money on self-employment taxes. If you pay taxes as a sole proprietor, you pay self-employment taxes on all of your profits because the business’s earnings are also considered the owner’s. But with an S corporation, the owner can pay themselves a reasonable salary and then only pay self-employment taxes on that amount. They can still pay themselves the full profit — they simply treat it as a distribution rather than their salary.

Depending on your income level and financial situation, any one of these options could be a good solution for your business.

LLC tax deductions

LLC owners have the opportunity to take advantage of many different business deductions, including the cost of forming your LLC. Keep in mind that the process for claiming these deductions depends on how an LLC owner chooses to be taxed. If you choose to have your profits pass through as a sole proprietor, then you also claim your deductions at the personal level. If you pay taxes as a corporation, then you claim your deductions at the business level.

Deductible business expenses include (but aren’t limited to):

Business meals
Bank fees
Home office
Internet expenses

Disadvantages of an LLC

There are some huge advantages to structuring your business as an LLC, but we’d be remiss if we didn’t also address the downsides of this setup. 

Self-employment taxes

When you earn a paycheck from an employer, you pay payroll taxes such as Social Security and Medicare taxes. Your employer pays the same amount. When you own an LLC, you have to foot the bill for both the employer and the employee side of these taxes — this is known as the self-employment tax. While there are ways for LLCs to reduce the amount they pay in self-employment taxes (such as filing taxes as an S corporation), you’ll still pay at least some amount.

Taxes on all profits

If you choose to pay taxes using the default sole proprietor tax laws, you’ll pay income taxes on all of your business’s profits, even if you decide to leave them in the business. With pass-through taxation, all of the business’s income is considered the business owner’s income. It doesn’t matter if you leave it in the business or pay yourself. It can be frustrating to pay income taxes on the money you aren’t actually taking home as income.

Next Steps for You

An LLC is one of the most flexible types of businesses. Owners have the ability to pay taxes as sole proprietors, C corporations, or S corporations and take advantage of the benefits that come with them. LLCs are formed at the state level.

To start the process, file your articles of organization with the appropriate government authority, often the Secretary of State. Once you’ve completed this process, you can consult a tax professional to find out how to start taking advantage of the benefits we’ve discussed.

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Personal Capital compensates Erin Gobler for providing the content contained in this blog post.