Tax Benefits of an LLC
Forming a limited liability company (LLC) offers several potential tax benefits for business owners. Understanding the potentially significant tax benefits of an LLC will help small business owners optimize their tax bills.
For many entrepreneurs, LLCs offer a sweet spot between personal liability protection and significant tax advantages. This translates to more money available to fuel business growth.
1. Pass-Through Taxation
Pass-through taxation is perhaps the biggest advantage of an LLC from a tax perspective. LLCs are considered "pass-through entities." This means the business itself doesn't pay corporate federal income taxes. Instead, the LLC’s profits or losses "pass through" to the members of the LLC. This income is then reported on each member’s personal tax return.
The main advantage of pass-through taxation is that business owners avoid paying taxes twice on the same income (known as “double taxation”). Double taxation occurs when a corporation pays taxes on its profits and shareholders pay taxes again on the dividends they receive from the corporation. A "pass through" taxation structure is therefore beneficial for most small business owners.
2. Tax Flexibility
Choosing how you're taxed is one of the clearest advantages of setting up an LLC. Your small business can elect to pay taxes as a sole proprietorship (classified as a “disregarded entity” by the IRS), a partnership, or an S or C corporation—depending on how many members the LLC has.
Each of these options has clear advantages and disadvantages. Perhaps the biggest of these decisions is whether you want your business to benefit from "pass-through" taxation. If this is the case, set your business up as a sole proprietorship, partnership, or S corp.
While C corps don't benefit from the perks associated with a "pass-through" business structure, their main tax benefit is a flat 21% corporate tax rate. This doesn't charge, regardless of how much your business makes in profits.
Consult a Tax Expert When Choosing a Business Structure
Navigating Internal Revenue Service (IRS) rules can be challenging. Furthermore, state-level taxation laws differ from state to state.
For that reason, many small business owners get help from tax planning experts when choosing a business structure. Tax professionals can compare the taxes you would pay with different business structures to help you determine the business structure that will allow you to keep more of your profits where they belong: in your business.
3. Pay Less Self-Employment Tax
You may be able to reduce the amount you pay in self-employment taxes if you file taxes as an S corp. This is because an S-corp tax classification allows business owners to categorize some income as salary and some as distributions. It is thought that 60% of LLC owners file taxes as S corporations to reduce self-employment tax.
Profits in an S corp are shared in two ways: firstly, as a regular salary and then as a distribution of the profits your company makes. Your "reasonable" salary is subject to self-employment taxes. However, the remaining distribution of business profits is only subject to income tax. This means your total tax liability will drop.
Please note: Distributions from an S corporation are classed as “non-dividend distributions,” so they are not subject to capital gains tax.
4. Qualified Business Income Deduction (QBID)
The QBI deduction allows eligible business owners, including some LLC owners, to deduct up to 20% of their qualified business income from their total taxable income. This 20% can be claimed in addition to standard and itemized deductions, including business expense deductions.
Which Businesses Can Claim the QBI Deduction?
Qualifying small business owners and self-employed workers may be able to claim the QBI deduction. This is partly industry-related as some businesses are exempt.
How Much Can You Claim for the QBI Deduction?
QBI is deducted once capital gains or losses, dividends, or interest income have been deducted from the business's profits.
Claim the QBI Deduction While You Still Can
2024 is the last year small businesses can claim the QBI deduction. Make sure you take advantage of the significant benefits it offers this year!
5. Continuity of Ownership
If you're a member of a multi-member LLC and an owner exits or passes away, the LLC doesn't automatically dissolve. This protects the business and offers continuity for the remaining members. What happens when a member departs from a multi-member LLC will depend on the nature of their departure:
If a Member Passes Away
There are various ways of proceeding in the unfortunate event of the death of a member:
The deceased member's heirs could inherit their share of ownership. They could have the same power as other members or inherit the member's interests but have no voting rights.
The remaining members could alternatively "buy out" the deceased member's share for a fair market price.
Owners in multi-member LLCs must specify in their will who inherits their assets and share of the business when they pass away.
If a Member Chooses to Leave the LLC
Leaving an LLC voluntarily will be subject to the operating agreement in place. There are two main options for transferring membership interest when an owner wishes to leave an LLC:
Transferring Membership Interest: The member could transfer their membership interest to a third party. This person could be a current member or somebody who wishes to join the LLC.
Selling Membership Interest: This follows the same principle as transferring membership interest, but selling involves the transfer of funds. Members may be obliged to offer their membership to the remaining members first before offering it to outside parties.
Maximize Your LLC Tax Benefits
LLCs offer significant tax advantages for business owners, particularly with the pass-through taxation structure. The ability to choose the most favorable tax structure for your business and potentially benefit from the QBI deduction adds to the financial appeal of this business structure.
Reducing your LLC's tax burden as much as possible is best done with the support of a tax professional who understands the intricacies of Florida tax law. Rather than overpay on your taxes, channel your business profits into taking your LLC from strength to strength.
