How LLCs Protect Assets and Offer Tax Advantages
Limited Liability Company protects the owner(s) personal assets in the event of a lawsuit or debt collection against the LLC. But did you know they have certain tax advantages, which have made LLCs popular among small business owners? Because LLCs do not pay federal taxes on business income, the individuals who own the business claim the income on their individual tax returns, thus avoiding double taxation. So then, how are LLCs taxed and, what tax form does an LLC file, and what about the employees who aren’t owners?
How LLCs Help Minimize Taxes for Small Businesses
Let’s imagine you’re starting a new business. You have a few employees who want to work for you but aren’t owners of your company, and you want to refrain from paying more than what’s necessary in taxes each year. How should you go about this? Depending on your needs, size, and company members (owners), claiming your business as an LLC may be most ideal. Because of how the IRS views these types of businesses, LLCs avoid double taxation and certain regulations that other larger-scale companies have. Let’s discuss why this is.
LLCs are considered a pass-through entity, where income made by the company passes through to the owners. LLC tax benefits, including pass-through taxation, allow owners to avoid double taxation by paying taxes only on their personal returns. As a result, the LLC does not pay federal taxes on income; rather, it is reported on the individual taxes of the owner(s). However, an LLC must pay payroll taxes if it has employees and a self-employment tax.
Understanding LLC Tax Forms
Just like an LLC is a unique kind of business, the tax forms required vary by LLC. To begin, you must determine what kind of LLC you are running. Single-member and multi-member LLCs file two different forms.
If the company has a sole owner, it is classified as a single-member LLC. Single-member LLCs will file Form 1040 Schedule C to report the income generated by the business.
But what if you have a partner or shareholders? In this situation, your company may identify as a multi-member LLC. These companies have a more complex tax report and require a bit more in-depth review. Multi-member LLCs will file Form 1065, where they will report profits, losses, deductions, and credits related to the business’s functions. On top of this, multi-member LLCs will also have to file Schedule-K documents for each member, in which each member reports any income, deductions, and credits received from the LLC. In some situations, a multi-member LLC may file as a corporation by completing Form 8832. This is most commonly done when an LLC does not want to accept its default tax classification or wishes to change it.
Example of a Multi-Member LLC
Matthew is starting a company with his good friend John. Both have agreed to take on the responsibility that comes with this, agreeing to be partners who share the title of co-owner and forming a multi-member LLC. Matthew will handle the finances while John does the marketing and face-to-face sales. Both will need to record the profits, losses, and deductions they incur as a result of starting this company and report them on their individual tax forms. As a result of this, they avoid being double taxed, once as a company and once individually.
Expanding Ownership and Responsibilities
As their business grows, they gain the interest of others who want a stake in the company. After some discussion, Matthew and John agree to expand ownership to these new members. By doing this, they assume responsibility for recording each member’s income, deductions, and credits from the company through a Schedule K form. They will also be responsible for payroll and self-employment taxes for any employees they hire after the expansion.
Filing as an S-Corporation or Corporation
The other two options that an LLC may file under depend on if they are classified as an S-Corporation or Corporation. S-Corporations will file Form 1120-S, and Corporations will file Form 1120. However, no matter how you choose to file, it is important you keep the documents consistent from year to year.
What Are the Tax Benefits of an LLC?
Filing as an LLC can offer a company certain tax breaks, especially when taking advantage of certain deductions and credits. Most business expenses related to the LLC can be deducted from the gross income, which in turn can lower the tax burden. The initial start-up costs, such as marketing material, legal fees, permits, and the operational costs thereafter, are approved deductions by the IRS.
By taking advantage of LLC tax benefits, such as deductible business expenses, you can reduce your overall tax burden and increase savings. It is important to discuss with a tax professional the types of deductions and credits your business qualifies for. That’s where our DeMar Consulting Group tax experts come in! Schedule a free consultation with one of our tax professionals to make the most of your business tax returns this year.
