Answers to common questions business owners ask about saving on taxes as a Limited Liability Company (LLC) and how you can maximize deductions.
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How are LLCs taxed? |
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How can an LLC reduce its taxes? |
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Managing an LLC |
As a business structure, the primary purpose of an LLC is to protect the owners’ personal assets from debt collection and lawsuits aimed at the LLC. However, LLCs also enjoy certain tax advantages that make them popular, especially for small business owners.
The following is a guide to some of the most common questions current and prospective business owners have about how LLCs are taxed and strategies LLCs can use to reduce their tax burden.
How are LLCs taxed?
LLCs are considered “pass-through entities,” which means the LLC itself does not pay federal income taxes on business income. Instead, income “passes through” to individual members of the LLC, who pay federal income tax earned from the LLC via their own individual tax returns. This is how LLCs avoid double taxation (i.e., taxation at both the federal and individual level), and it is the biggest difference between an LLC and a C corporation (C corp).
Now, if an LLC has employees in addition to its members, or owners, the LLC must collect and pay payroll taxes, which include unemployment, Medicare, and Social Security taxes — also known as FICA taxes (i.e., Federal Insurance Contributions Act), or “self-employment” tax. Payroll taxes are paid on a “pay-as-you-go” schedule determined by the IRS and are usually paid via the Electronic Federal Tax Payment System, or EFTPS. Meanwhile, unemployment taxes are paid by the LLC, which must file Form 940 by January 31st of the tax year; payments are then made by the last day of each subsequent month during the quarter. To pay Social Security and Medicare taxes, the LLC files Form 941 on the last day of the month following each quarter, and the taxes are generally paid on a monthly or semi-monthly basis.
How are LLC members taxed?
LLCs are taxed differently depending on the makeup of their membership setup, single member vs. multiple members:
- If it is a single-member LLC: That individual will use Form 1040 to report income generated from the business and Schedule C to report expenses.
- If it is a multi-member LLC: The LLC files Form 1065, U. S. Return of Partnership Income, on which the LLC reports profits, losses, credits, and deductions related to the business. The LLC then prepares Schedule K-1 documents for each member of the LLC. When filing their own taxes, individual members use Schedule K-1 (Form 1065) to show their share of income, credits, and deductions received from the LLC. The percentage each member of the LLC receives is pre-determined in the LLC’s operating agreement.
Do LLC members have to pay self-employment tax?
Yes. LLC members are considered self-employed individuals, and self-employed individuals do not have FICA taxes (e.g., Social Security, Medicare) withdrawn from their paychecks. Instead, self-employed people pay FICA taxes directly to the IRS—which is known as the self-employment tax.
In 2024, the self-employment tax is 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare. Technically speaking, only the first $168,600 in earnings is subject to the Social Security portion, but individuals who are single filers and earn $200,000 or more pay an additional 0.9% Medicare tax — or, if filing jointly with a spouse, the threshold amount is $250,000.
To pay the self-employment tax, each LLC member calculates the self-employment tax themselves, using Schedule SE (Form 1040 or Form 1040-SR). There are ways to get around paying self-employment taxes, but they involve filing as an S corporation or a C corporation and following certain rules that don’t normally apply to LLCs.
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BookPPC’s Guide to Limited Liability Companies identifies and explains federal tax issues encountered by LLCs and their members. |
How can an LLC reduce its taxes?
There are a number of ways an LLC can reduce its tax burden, most of which are aimed at lowering the LLC owner’s taxable income. For example, business deductions can be claimed as capital expenditures which are subtracted from the LLC’s gross income. There are more complicated ways to find tax savings, such as changing your company’s filing status, but these should only be pursued with the help of a qualified tax professional.
Tax deductions
As an LLC, most expenses associated with the business are tax-deductible. So, in order to lower the business’s total taxable income, it makes strategic sense to have as many business-related expenses as possible. These expenses can then be deducted from the LLC’s gross income, lowering the business’s overall tax burden. The IRS allows LLCs to deduct initial start-up costs — e.g., marketing materials, travel, permits, legal fees, research — and thereafter allows deductions for a wide variety of operational costs, including:
- Computers, printers, and other office supplies
- Phone and internet
- Website development
- Graphic design (e.g., branding, logos, banners, business cards, etc.)
- Business meals/entertainment
- Travel
- Uncollected debts
- Medical/healthcare expenses
- Property/rent
- Tools and technology
- Self-employment taxes
Tip: Don’t just throw receipts in a shoebox and hope for the best. There is an entire cottage industry devoted to business-expense tracking apps which can help business owners track expenses. Most can organize expenses to make things easier when taxes are due, and some are really full-blown accounting programs that LLC owners can use to manage their entire business.
Set up retirement accounts
LLCs can set up their own retirement accounts and use them to either reduce or defer taxes. The most popular vehicles for LLC retirement accounts are a SEP-IRA, Solo 401k, IRA (traditional or Roth), or a Simple IRA. In each case, contributions are deductible because they are considered “compensation.” Each option has its pros and cons, but for tax purposes (in addition to saving for retirement), such accounts can help an LLC reduce its taxable gross income, especially in years when the business has done well and there is extra cash available to invest.
Deduct health insurance
One of the perks of self-employment through an LLC is that healthcare premiums and other medical expenses (including vision and dental) are deductible. The only stipulations are that the business has to have made a profit, and the LLC owner can’t be eligible for a plan through their spouse’s employer.
Tip: In addition to health insurance premiums, one oft-overlooked medical expense is mileage. Mileage to and from doctor appointments, to and from the hospital, and even to and from the pharmacy — all are tax deductible. If you decide to take a rideshare service, that’s deductible too. So are the costs for glasses, hearing aids, medications, and any other unreimbursed medical expenses.
File as an S corporation
LLCs have the option of filing as an S corp., the main benefit of which is it provides a mechanism for reducing self-employment taxes. Under an S corp structure, the owner of an LLC can be considered an employee and receive a salary. Self-employment taxes only have to be paid on the salary (or salaries); the rest of the LLC/S corp’s profits can be distributed to members as dividends, which are not subject to the self-employment tax. Under this arrangement, the business is still considered an LLC and is not subject to S corp administrative rules, but is treated by the IRS as an S corp.
Tip: It is possible for an LLC to file as a C corp, so profits are taxed at the corporate income tax rate. However, this causes the risk of double taxation — i.e., having profits taxed a second time on one’s personal taxes. This strategy only makes sense under certain circumstances, and only an experienced tax attorney can determine if it’s a strategy worth considering.
Use the Qualified Business Income (QBI) deduction
The Qualified Business Income (QBI) deduction, or Section 199A deduction, is another deduction available to eligible pass-through entities such as an LLC or S corp. The QBI deduction is up to 20% depending on total taxable income, and can be taken in addition to standard and itemized deductions.
Not every business can claim a QBI deduction, however. To be eligible, a business must be in a “specified service trade or business,” such as a lawyer, doctor, consultant, financial planner, or accountant. However, the list of possible professions also includes performing artists, athletes, farmers, and many other businesses that rely on the skill or reputation of one or more employees.
The QBI is deducted from a business’s net profit minus capital gains/losses, dividends, or interest income. As of 2024, a single filer who earns less than $191,950 may be eligible to take the full 20% deduction, whereas a single filer who earns $191,500 to $241,950 may only be eligible to take a partial deduction. For those filing jointly, the upper income limit for the full 20% deduction is $383,900, and for joint filers who earn between $383,900 and $483,900, a partial deduction may apply.
Tip: The QBI also has up to a 20% deduction, calculated separately, for Real Estate Investment Trusts (REITs) and publicly traded partnerships (PTP), but there are certain limitations. Indeed, calculating QBI can be quite complex, so consultation with a tax professional is advised.
Managing an LLC
Running a business as an LLC can be both rewarding and challenging, but to get the most out of the experience, make sure you take advantage of all the available tax savings. Compared to other business entities, LLCs have an advantage in that they are not subject to double taxation, which means LLCs don’t have to pay the type of federal taxes that C corps do. In addition, they have the option of choosing their own tax status (LLC, S corp, or C corp), which can yield even more tax advantages.
In most cases, however, LLCs simply file with the IRS as LLCs and lower their tax burden by taking advantage of the deductions and deferral options available under the LLC structure. Other ways to reduce LLC taxes include putting money away in a retirement account, deducting health insurance premiums and, if eligible, taking the QBI deduction for service-oriented businesses.
Finally, it should be noted that as soon as an LLC begins to grow and move beyond a sole proprietorship, tax filing and reporting can quickly get more complicated and time consuming. If products are being sold across state lines or internationally, for example, a more robust tax software alternative such as ONESOURCE may be worth considering.
ONESOURCE corporate tax software has flexible modules for tax planning and preparation, and can automate much of the tax process. It’s also surprisingly affordable. And for LLCs with multiple investors, K1-Analyzer can help streamline the process of reporting profits, losses, credits, and deductions to individual investors. Both options automate the most time-consuming aspects of the tax process, giving business owners peace of mind that their tax filing and reporting are accurate, maximizing tax savings and lowering the risk of audits.
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