What Are the Tax Advantages & Disadvantages of an LLC

When deciding on a structure for your business, an LLC is likely on your list of options to explore. Similar to many other business structures, there are both tax advantages and disadvantages for filing as an LLC and understanding these tax implications will help you determine if this is the best business structure for your business. The business formation attorneys at Evolution Tax and Legal is breaking down these advantages and disadvantages, and how our team of seasoned professionals can help you when forming your business entity.

What Is an LLC?

A limited liability corporation (LLC) is a newer legal business entity than the classic corporations and partnerships. Forming an LLC is similar to forming a corporation or partnership, as the Articles of Organization will be filed with the state the LLC is operating out of and a fee will be paid to the state upon filing. For many entrepreneurs, an LLC is a beneficial legal entity because it limits the personal liability a business owner can face if the business runs into any lawsuits or legal difficulties throughout business operations.

How Does an LLC Pay Income Taxes?

The IRS does not have a specific tax category for LLCs, so they are able to use the tax categories for other business types when paying income taxes. The default tax strategy for an LLC with one owner, also known as a Single Member LLC, is to be taxed as a disregarded entity. This tax category will require the owner to file Schedule C to report business income, similar to the way a sole proprietorship will file tax returns. The Schedule C net income includes other income that the owner has accrued and reported on Form 1040/1040-SR.

For limited liability corporations that have multiple owners, or members, the default tax strategy is for these members to file taxes similar to a partnership’s tax filings. The partnership tax return is prepared using Form 1065, and the individual must determine their individual tax payment using Schedule K-1. This schedule will be included on the individual’s tax return, and each member of the LLC must file their individual taxes with this schedule.

Tax Advantages of a Limited Liability Company (LLC)

There are a few key tax advantages to registering as an LLC, as opposed to another form of business entity. One such advantage is that registering as an LLC helps members avoid double taxation. Other business entities, such as corporations, face double taxation as the corporation must pay corporate taxes and owners must pay taxes on the dividends they receive as shareholders of a corporation. Members of an LLC pay taxes as the business owner, and are not subject to double taxation.

Depending on the state in which an LLC is registered, another advantage may be the avoidance of corporate franchise tax. Certain states do not require LLCs to pay corporate franchise taxes, but be sure to double check within the state your LLC may be registering to ensure this is a benefit you may receive. 

Owners of an LLC also have the benefit of small business tax deductions. The Qualified Business Income Deduction allows LLC owners to receive a 20% tax deduction on their business net income, along with other typical business deductions small business owners can access. Corporate shareholders do not have access to the QBI deduction. 

Tax Disadvantages of an LLC

Along with the advantages of registering as an LLC, it is beneficial to take at look at some of the disadvantages members of an LLC may face. One key disadvantage is that LLC owners must pay taxes on their profits, even if they have not yet received a distribution of the profits. Owners of a corporation typically do not pay taxes on profits until they are received in the form of dividends. 

LLC owners also face a large amount of self employment taxes each year. While corporation owners only have to pay for half of their Social Security and Medicare costs each year, and the company pays the other half, LLC members must pay both the employer and employee portions of these costs, as is customary with those who are self employed. 

How the Business Entity Formation Attorneys at Evolution Tax and Legal Can Help

Deciding how to register your business entity is an intricate decision, and it is imperative that you understand the different types of entities and the benefits and disadvantages they may offer before making your final decision. It is beneficial to discuss your decision with a tax professional, to have a seasoned expert work with you and your unique business situation to decide what is best. The business entity formation attorneys at Evolution Tax and Legal have worked with countless business owners to register as a business entity, and ensure they are receiving the benefits that will work for their business. To start your journey to becoming a business entity today, contact the team at Evolution Tax and Legal.