Q: What Are the Tax Pros and Cons of LLCs? –Strategic Business Owner
A: Dear Strategic: LLCs, or “Limited Liability Companies,” bridge the gap between sole proprietorships and traditional corporations, meeting an unmet need in today’s dynamic small business world.
LLCs appeal to business owners because they combine the liability protection of a corporation with the tax advantages of a partnership (or, a Corporation if an election is filed to have the LLC taxed as an S-Corporation) and a tremendous amount of flexibility.
LLCs require registration with the appropriate state agency and a bit more paperwork than a sole proprietorship to get up and running. But that extra work is worth it for business owners looking for tax benefits along with extra liability protection. Let’s take a look at the tax pros and cons of LLCs.
How LLCs Are Taxed – LLCs are not taxed entities in the eyes of the IRS, unless an election is filed to indicate that desire. In general, LLCs with one member (i.e. owner) are taxed like sole proprietorships, while LLCs with more than one member are taxed as partnerships. The LLC itself does not pay taxes directly. Rather, an LLC’s income is passed through to the personal income tax of the member(s) and is taxed accordingly. You may also elect to file your LLC as an S-Corp which provides tax advantages such as savings on Medicare and Social Security taxes.
Pros – The total income of the owner(s) determines the tax rate for an LLC. So, even at higher total net incomes, LLCs can end up taxed at a lower rate than traditional corporations. And LLC owners are not subject to double taxation—paying taxes on both the corporation income and the dividend income. In addition, LLCs can opt to be taxed as an S-Corporation if it is advantageous.
Cons – LLCs also have limitations that can result in a larger tax liability. LLC owners must pay taxes on their distributive share of the profits, whether or not they received a distribution. And, if an S-election is not filed, all distributions are subject to self-employment tax. In some states, such as California, an additional tax is due on LLC revenue over a specific amount, so be sure to understand the tax laws in our State, or contact us before choosing an LLC structure.
In some states, an LLC may have to pay property tax, whereas a corporation may be exempt from such a requirement.
LLC owners are considered self-employed if they work for the company, and all income distributions from an LLC is considered earned income, unless an election is filed to tax the LLC as an S-Corporation. Accordingly, LLC owners (without an S-election) pay the full amount of self-employment taxes for Social Security and Medicare according to the total taxable income of the LLC. Filing an S-Election allows the owners of the LLC to pay self-employment tax only on the income paid via payroll with distributions from the LLC not subject to self-employment taxes.
If you need help deciding how to structure your business, start by sitting down with a Creative Business Lawyer®. A Creative Business Lawyer®, can help you make strategic decisions about the structure of your business so you can maximize your tax benefits. They can also help you protect your business’s financial future with careful legal planning today.