One of the most important and difficult decisions an entrepreneur needs to make is choosing the type of organization the business will be. Each type has different advantages, tax implications, filings, and legal rules. It can be quite confusing to know if the business should be registered as a Sole Proprietorship, Partnership, LLC or Corporation. LLCs are one of the most popular choices for small and new businesses. An LLC offers legal protection as well as has certain tax advantages. Below we list the tax advantages an LLC offers small businesses and entrepreneurs.
LLC can be classified in two different ways by the IRS, this also determines how the LLC will be taxed. LLCs are classified as either a corporation or a pass-through for a proprietorship.
No Double Taxation
One of the best advantages of LLC’s especially compared to corporations is that there is no double taxation for the owners. In a corporation, the business owner pays corporate taxes on business profits as well as personal tax on income from the corporation and dividends from shares. A corporation is subject to double taxation. LLCs are not subject to this.
If the LLC is classified as a corporation by the IRS, the LLC will be liable for corporate taxes on the income received by the LLC, with no flow-through to individual members. The members will still pay taxes on distributions.
For most small businesses the LLC is classified as a pass-through for proprietorship, allowing for the funds earned by the business owner to pass-through to their individual taxes. In these cases, the LLC does not pay income tax. The business owner pays taxes on the profits of the company at a lower rate than that paid on corporate income tax.
Tax Deduction for Small Business Owners
There is a new tax deduction available for business owners that have an LLC. This deduction is called the Qualified Business Income (QBI) deduction. This is not available for corporate shareholders. The QBI allows business owners who have an LLC to get a 20% tax deduction from their business net income. This is additional to the normal business expense deductions.
Avoidance of Corporate Franchise Taxes
This benefit is dependent on state rules. In some states, LLCs do not have to pay state corporate franchise taxes. Check your state rules regarding this. All states require corporations to pay these taxes, so in the states that do not require this from LLC’s is a big benefit.
Losses also, like profits of an LLC, flows to the owner’s personal taxes. This allows the business owner to deduct some business losses if the LLC suffered a loss in that financial year. The tax deduction for the losses may not be more than the total loss to the owner. The limited liability an LLC offers business owners can be very beneficial to business owners with regard to major losses.
Owner Health Insurance
Members of LLCs can deduct 100% of the health insurance premiums they pay. This can be done to the extent that their shares of the LLC’s net profit are equal. This can be done because the profits of an LLC are regarded as income to the business owner. This is perfect for business owners who have large self-insurance payments.
Business owners face an important decision when choosing which business type they want to register. A sole proprietorship and partnerships cost less money, however, gives the business owner no limited liability protection. Usually, business owners with smaller businesses like photography, artists, and studios stick to sole proprietorship and partnerships.
LLCs are a great way for business owners to get personal liability protection from the business. The business is seen as a separate entity from the owners, as mentioned above there are many tax benefits to having an LLC. The business is registered and fillings are done. New and small businesses are usually attracted to the LLC route. A business more formal than the proprietorship and partnership should be an LLC.
Corporations are big businesses. They have their own tax benefits. However, they are difficult to manage as directors and officers are appointed. There are also shareholders. One only starts a corporation if there is a benefit to complex management and big profit overflows from year to year.