Whether you are still deciding on a business structure, or already chosen to register an LLC (Limited Liability Company), it is important to know how the business will be taxed. LLCs are not listed under separate tax classifications by the IRS (Internal Revenue Service). It essentially means that the body of law which regulates all federal income tax (the IRS) treats an LLC as if it were one of the other recognized entities. The real benefit then of an LLC structure is that it can choose how it wants to be taxed, thus giving the business various options.
An LLC can elect to be taxed under four different classification namely:
- Single-member LLC (Disregarded entity)
- Multiple-member LLC (Partnership)
- C-Corporation
- S-Corporation
The default tax structure for an LLC with only one owner (also called member) is as a disregarded entity. Depending on the type of business activities and number of members, llc taxes will fall within either of the four mentioned categories. Choosing the correct one will entirely depend on how the business is structured.
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Pros of Being Taxed as an LLC
No more Double Taxation
Choosing to be taxed as an LLC rather than a corporation means that the business will pay taxes on the profits, but the members will not. A corporation pays taxes on its profits and as those profits are divided to shareholders via dividends, the shareholders are also taxed on those dividends (double taxation). As an LLC, this double taxation can be avoided.
Avoid Corporate Franchise Tax.
It is possible to avoid corporate franchise tax for an LLC in some states. This however varies from state to state so it is best to check the states rules and regulations first.
Small Business Owner Tax Deductions
Qualified Business Income (QBI) deduction is a new deduction available to LLC owners, but not corporate owners. The QBI deduction allows LLC owners to get a 20% deduction on their net income. This is in addition to the normal business expenditures.
Note: An LLC can choose to be taxed as a either a C-corporation or an S-corporation in order to get tax advantages. The business will still operate as an LLC, but will be taxed as a corporation. Form 8832 can be completed for C-corporation tax treatment or Form 2553 for S-corporation tax treatment.
Flexibility
As previously stated, probably the best advantage of an LLC is being able to choose it’s tax structure. This means that the business can choose an option that offers the best tax advantages provided they meet the required criteria.
Disadvantages of Being Taxed as an LLC
Tax on Profits Shared
Members of an LLC are subject to pay taxes on their share of the profits, even if those profits have not yet been distributed to them. In the case of a corporation the shareholders are only taxed on the profits when it is distributed as dividends. In some states corporations are also exempt from property tax, but other entities such as LLCs are not.
Self-Employment Taxes
Self-employment (Medicare / Security) tax is a tax that is primarily for individuals who work for themselves. An LLC owner has to pay both the employer and employee portion of the tax. With corporations, owners that also serve as employees only have to pay half of the self-employment tax and the corporation covers the other half. In some instances, LLC owners may well end up paying more tax than an owner of a corporation.
The Best Choice for your Business
Every business is unique and different in their structure and operations. One can therefore assume that each business’s tax situation also differs. As a business grows, the tax requirements of the business may also need to change. Keep in mind that some states tax LLCs differently than the federal government so find out the state in question’s regulations before registering an LLC.
It is advisable to have a knowledgeable tax advisor to assist the business in making the best decisions with the most benefits for the business. A tax advisor can also help the business owners to be well-informed when any changes in tax structure is required.