Limited Liability Company Tax Advantages

By Jennifer Kiesewetter, J.D.

Limited Liability Company Tax Advantages

By Jennifer Kiesewetter, J.D.

Limited liability companies, or LLCs, are one of the most popular ways to form a business. The tax advantages is one reason for their immense popularity. They generally are easier to form and manage than their corporate companions—S and C corporations. Despite their ease of formation, LLCs still give their owners (also referred to as members) protection from personal liability for specific actions or inactions, much like corporations do. Although this structure serves as a benefit, the favorable taxation that they receive are a primary reason for choosing this type of professional structure.

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Pass-Through Income

The primary reason LLCs receive favorable taxation is because of the pass-through income benefit. The professional earnings "pass through" to its members, without first being expensed at the corporate level. Thus, the rate depends on the their individual tax bracket. Typical C corps. pay twice, known as double taxation. For example, the business itself pays on its income at the corporate rates. Then, the Internal Revenue Service (IRS) charges the owners on any distributions received from the company.

With LLCs only being required to pay once, this can not only save money in the long run, but it can help such entities grow and mature faster. The concept of pass-through income is the one of the primary benefits.

Flexible Taxation

LLCs have flexible options based on how they form. For example, the IRS does not have a category for this type of business. Instead, for one-person entities, it is taxed as a sole proprietorship. For those with more than one member, it is treated as a partnership, as all profits are passed onto them whether they take a distribution or not. Corporate owners are not taxed on all profits unless they receive a distribution of the earnings.

Additionally, LLC members must pay all of their own employment taxes, known as self-employment income. This includes Social Security and Medicare expenses. As a corporate owner, the IRS treats them as employees; thus they're only required to pay half of their employment expenses where the company pays the other half.

Taxation Structures

LLCs can choose to be taxed as either an S or a C corp. This is simply a tax election and not a business formation election under state law, meaning the company still operates as an LLC. The members can elect S corp. taxation, which also embraces pass-through income. Although this imposes some limitations, one benefit is that the IRS treats them as employees, not individuals. Therefore, only the wages paid to the owner are subject to employment fees. Any other earnings passed through are dividends and not subject to it. By choosing this, members can do more planning than with an LLC that is taxed as either a sole proprietor or a partnership.

These entities can also elect C corp. taxation. In this case, the IRS treats the owners as employees of the company, and therefore, they receive a Form W-2 for their wages. However, as a C corp., the company is taxed twice—once at the business level and then again at the owner level. One common reason for electing such status is if the company is seeking investments from venture capitalists. Additionally, the company isn't subject to as many restrictions as required by S corporations.

When forming your entity, you should carefully explore the taxation options available to LLCs. Depending upon your goals, this type of structure could provide several benefits to you.

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