How Having An LLC Can Help You Avoid Paying Too Much Tax

Choosing the right business entity for your company can have a huge impact on how you pay business income tax. Many businesses elect to set up their business with an LLC entity structure, opening up many tax-saving opportunities.

This post helps you understand the basics of paying taxes as an LLC entity, and the advantages of deductions and credits you can leverage to avoid paying too much in business income tax.

Taxes for LLC Explained

Before we get into the tax advantages of an LLC, it’s important that we lay the groundwork for how LLC taxes work. At the federal tax level, LLCs are considered pass-through entities. This means that LLCs (as well as sole proprietorships and S-corps) are not taxed on the entity level. Rather, any income generated by the LLC is passed to the business owners who then pay taxes on that business income on their personal income return. Although not all states levy a state-based LLC tax, you should check to see the unique tax regulations in your state before proceeding.

How an LLC actually pays those taxes is another matter. The ownership structure of the LLC plays an essential role in determining how LLC taxes are paid. There are three ways to establish an LLC structure:

• Single-member LLC
• Multi-member LLC
• C-corporation or S-corporation classification

Each of these classifications pays income taxes differently. Let’s dive deeper into each one.

Paying Income Tax as a Single-Member LLC

As the sole owner of an LLC, you have a few tax advantages. First, the IRS deems single-member LLCs as disregarded entities. This means that as the sole owner of an LLC, you are not required to file a separate income tax return for your LLC income. Instead, you report your LLC income and expenses on your personal income tax return. This process is the same for business owners operating a sole proprietorship.

Depending on the state in which you live, there may be additional LLC-related fees if you make over a certain amount of income. For example, LLCs in California incur an annual LLC tax of $800 and an annual fee proportionate to your LLC’s annual income. Other states impose franchise taxes along with the annual LLC tax. You must know how your state taxes LLC entities before deciding to incorporate your own business.

Paying Income as a Multi-Member LLC

Similar to the single-member LLC tax structure, multi-member LLCs are considered pass-through entities. Each member of the LLC pays taxes on the LLC’s business income on their personal tax return, relative to their ownership share of the LLC.

Additional state taxes also apply to this type of LLC entity structure, and you should ensure you’re prepared to file at both the federal and state levels, according to your state’s regulatory guidance.

Paying Income Taxes as a C-Corporation or S-Corporation LLC

Single-member LLC and multi-member LLC entities have a reasonably straightforward income tax return process. However, things can be more complicated if you choose to classify your business as a C-corporation or S-corporation.

Paying income tax as an S-corporation begins similarly to the other LLC entity types. In this tax status, you are still considered a pass-through entity. However, you must prepare and file a separate K-1 form for each of the corporation’s shareholders to demonstrate each person’s earnings and deductions. Then, you file an annual tax return on Form 1120S, which you can read more about here.

If you decide to file as a C-corporation, you will be subject to the federal flat corporate tax rate of 21%. On top of the federal tax, state and local corporate taxes may also apply. To file C-corporation taxes, read more about filing Form 1120 here.

As you can see, setting up an LLC doesn’t have to be a daunting endeavor. Carefully consider how each entity’s business tax requirements work with your projected business income, and ensure you’re accounting for any state and local taxes that may apply.

Tax Advantages of an LLC

Now that we’ve how an LLC entity structure impacts your business and tax filing process, this next section highlights several tax advantages you should leverage as an LLC.

Qualified Business Income Deduction

The qualified business income deduction (or QBI as it is more commonly known) is a major tax advantage for pass-through entities like the ones we outlined above. This tax deduction allows eligible LLCs, partnerships, sole proprietorships, and S-corporations, to deduct up to 20% of qualified net business income on their taxes.

This tax deduction became available to pass-through entities for the 2019 tax filing season. In 2022, there are new income thresholds you should be aware of before filing for the deduction:

• Married Filing Jointly has an income threshold of $340,100
• All other filing statuses have an income threshold of $170,050

While this deduction expires after 2025, you should contact us to ensure taking advantage of this deduction is the right tax-saving move for your LLC.

Increased Contribution Limits

Another tax advantage of setting up your business as an LLC is the increased contribution limits for your retirement accounts and life insurance policies. In the case of a retirement account, a single-member LLC can contribute up to 20% of net compensation. Multi-member LLCs may contribute up to 25% of net compensation.

Rules regarding SEP IRA depend on your particular entity structure, so it’s essential to speak with an experienced accountant to ensure you are following the appropriate tax laws. Set up a free consultation with us here.

While life insurance is not considered a business expense by the IRS, the federal agency does allow you to take advantage of tax-saving deductions in some cases. If you are an LLC, S-corp, partnership, or sole proprietorship, you may be able to deduct the life insurance premiums for you and any employees your business employs.

Other Tax Advantages of an LLC

There is a long list of business-related expenses you can deduct as an LLC business entity. Many of them may already be familiar to you, including business costs, office supplies, business taxes, utilities, and rent.

However, there are other deductions you should consider to help you avoid paying too much in business taxes as an LLC. These deductions include:

• Charitable tax credit
• Health insurance expenses
• Home office expenses
• Business-related conferences and business travel

If you’re interested in other, lesser-known tax write-offs for your LLC, check out our recent article here. And if you need more information about filing for an LLC entity status, reach out to our expert CPA team to schedule a free consultation. We can help you navigate the filing process with the state and ensure you’re ready to file the appropriate tax forms for your entity.

Meta Description: Several home improvement and repair expenses are eligible for deductions and can save you money on your tax bill. From energy-efficient upgrades and medical-related additions and modifications to home office-related expenses, there are several options for households looking to leverage tax-saving home improvement deductions. This post outlines the home improvements you can write off this tax season to save money.