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Sierra Campbell
Sierra Campbell
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Updated 5:41 p.m. UTC Feb. 28, 2024
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If you own a small company, you may be considering structuring your business as a limited liability corporation or LLC. LLCs are seen as a favorable entity type by many business owners. The “limited liability” portion of the name means that the personal assets of the members of the LLC are protected; they cannot be used to cover any obligations or debts of the company.
Beyond personal asset protection, there are several LLC tax benefits to consider. Explore these benefits in the next few sections to determine whether an LLC offers the ideal business structure for your entity.
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4 tax benefits of an LLC
There are several tax benefits of an LLC to consider when deciding whether it is the ideal structure for your business. These include flexibility in taxation, pass-through taxation, qualified income deductions and other tax deductions.
1. Pass-through taxation
Pass-through taxation is another reason to consider structuring your small business as an LLC. George Birrell, President of Taxhub, explained “the income, losses, gain, losses, credits, etc. from an LLC will flow through to the LLC members and they need to include their share of income/losses/deductions, etc. on their own personal income tax return.”
Compared to C corporations that face double taxation (at the company level and by the shareholders on dividends), LLCs are only taxed once.
2. Flexibility in taxation
One of the main benefits of an LLC is that it provides you with flexibility in regard to how your business is taxed. The way in which an LLC is taxed will depend on the selected tax status and the number of members. The four potential classifications include sole proprietorship, partnership, S corporation and C corporation.
Birrell explained, “An LLC is considered a ‘disregarded entity’ by the IRS, meaning the IRS has no tax law written for this specific entity unlike partnerships, S corps and C corps.”
- Sole-proprietorship: Single-member LLCs default to this tax status, also designated as a disregarded entity. All of the income and expenses from the business are passed through to the owner, who reports them on their return.
- Partnership: Multi-member LLCs default to a partnership tax status. The income of the LLC passes through to the members. Taxation of partnerships requires filing Form 1065 with the IRS and issuing Schedule K-1s for members to use when filing their taxes.
- C corporation: LLCs may choose to be taxed as a C corporation by filing Form 8832. With C corporation status, the net income of the company is double taxed at both the corporate level and at a more favorable rate on the after-tax profits, which are distributed as dividends.
- S corporation: To avoid the double taxation of a C corp, file form 2553 to choose S corporation status, setting your organization up as a pass-through entity. With S corps, taxes are filed based on the individual rate of each owner. The IRS requires that a reasonable wage be paid to all members.
As a disregarded entity, Birrell highlighted the “flexibility in tax status of an LLC. Specifically, the IRS allows LLCs to elect to be taxed as [an S corp or C corp]. Additionally, if there is only one member in the LLC, [it] can elect to be taxed as a sole proprietor.”
3. Qualified business income deductions
In 2017, with the passage of the 2017 Tax Cuts and Jobs Act, another benefit for LLCs was introduced. Owners of LLCs (and other pass-through businesses) can deduct up to 20% of their qualified business income (QBI). With this deduction, the LLC’s and owners’ taxable income is effectively reduced, without impacting the owner(s)’ adjusted gross income.
4. Other tax deductions
QBI deductions are not the only deductions LLCs can take to reduce their taxable income. Other potential deductions to explore with a qualified tax preparer include:
- Phone and internet services.
- Office supplies.
- Mileage and vehicle use.
- Travel expenses.
- Home office expenses.
- Business meals.
- Health insurance premiums.
- Disability insurance.
- Charitable donations.
LLC taxation vs. other business structures
The table below provides additional information about how LLC taxation compares with other common business entity types.
| SOLE PROPRIETORSHIP | C CORP | S CORP | LLC | |
|---|---|---|---|---|
Taxation | Profits are taxed one time on individuals’ profits/losses | Double taxation (taxes paid by the corporation and on shareholders’ dividends) | Profits are taxed one time for each shareholder’s portion of profits/losses | Profits are taxed one time for each shareholder’s portion of profits/losses |
Pass-through taxation | Yes | No | Yes | Yes |
Self- employment taxes | Yes | N/A | Minimized through reasonable salary payments and dividend distributions | Yes |
Liability | Personal assets of individual at risk | Limited liability protection of personal assets | Limited liability protection of personal assets | Limited liability protection of personal assets |
Featured LLC service offers
ZenBusiness
Via ZenBusiness’ website
Free version available
Yes
Lowest published package price
$199
Live chat
Yes: Human
LegalZoom
Via LegalZoom’s website
Free version available
Yes
Lowest published package price
$249
Live chat
Yes
Northwest Registered Agent
Via Northwest’s website
Free version available
No
Lowest published package price
$39
Live chat
Yes
Frequently asked questions (FAQs)
While there are several benefits to setting up an LLC, there are also some downsides to consider. If an LLC does not elect to be treated as a corporation, it will be taxed as a sole proprietorship or partnership.
Members will pay self-employment taxes, which include social security and medicare taxes, based on the net profits. Because of this, self-employment taxes are higher than what employees of a C corporation or S corporation pay.
The IRS requirement that LLC members receive a reasonable salary can also be a potential downside. Because of the potentially subjective nature of this, it can add some headaches for business owners trying to minimize their tax liabilities without drawing unwanted attention from the IRS.
Each business owner will need to weigh the pros and cons of setting up an LLC based on their specific taxation situation. Consulting with a tax professional can help you make an informed decision.
LLCs are often more tax advantageous than traditional corporations. They allow business owners to avoid double taxation and provide the flexibility of choosing whether to be taxed as a sole proprietorship, partnership, S corporation or C corporation.
Blueprint is an independent publisher and comparison service, not an investment advisor. The information provided is for educational purposes only and we encourage you to seek personalized advice from qualified professionals regarding specific financial decisions. Past performance is not indicative of future results.
Blueprint has an advertiser disclosure policy. The opinions, analyses, reviews or recommendations expressed in this article are those of the Blueprint editorial staff alone. Blueprint adheres to strict editorial integrity standards. The information is accurate as of the publish date, but always check the provider’s website for the most current information.
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Deirdre Mundorf is an educator turned freelance writer whose work hasbeen published by U.S. News and World Report, Bob Vila, Discover Magazine, and House Digest, among others. She specializes in writing about home and family-related topics.
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Sierra Campbell is a small business editor for USA Today Blueprint. She specializes in writing, editing and fact-checking content centered around helping businesses. She has worked as a digital content and show producer for several local TV stations, an editor for U.S. News & World Report and a freelance writer and editor for many companies. Sierra prides herself in delivering accurate and up-to-date information to readers. Her expertise includes credit card processing companies, e-commerce platforms, payroll software, accounting software and virtual private networks (VPNs). She also owns Editing by Sierra, where she offers editing services to writers of all backgrounds, including self-published and traditionally published authors.
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