The LLC Tax Benefits For Small Businesses In 2024

Taxation is a necessary part of doing business in the US. However, not all businesses are taxed in the same way. In the US, there are unique LLC tax benefits you can access as a business owner that you wouldn’t get from other types of businesses. The main benefit is being able to choose your LLC tax rate, by deciding which taxation structure your business will use. 

Let’s take a closer look at LLC tax benefits and what makes LLCs different from other business types, for income tax purposes. 

What Is An LLC?  

An LLC, or Limited Liability Company, is a type of business structure in the US. LLCs are registered in each state where they operate, rather than being registered nationally. An LLC can be formed for a specific time period, such as for the duration of an investment project, or indefinitely for regular businesses. 

LLC owners are called members. There are single-member LLCs and multi-member LLCs, depending on how many LLC owners are involved. An LLC as a business entity offers legal protection that sole proprietorships don’t, making the owner separate from the business in the same way corporate owners are distinct. This is true for small businesses, and it’s one of the main benefits of an LLC, along with the tax advantages. 

What are The Ways Of LLCs To Pay Income Taxes?

LLCs do not pay taxes on income. They are automatically considered pass-through entities, which means the income they make is passed through to the members, who will pay taxes on any income in their own individual tax filings. This will be considered a self-employment tax. 

Unlike other business entities, LLCs are not stuck with a default taxation status. Instead, a Limited Liability Company can elect to be taxed as either a c corporation or an s corporation. This would mean the corporation pays its own income taxes every year and the income from the business would not be passed through to the LLC’s members. However, dividends given to shareholders would still be taxed on individual tax returns. 

If an LLC is taxed normally, not as a corporation, the income will go through to the members, who will then pay for it through their own taxes. Here’s how it works for single and multi-member LLCs. 

Single-Member

A single-member LLC works in a similar way to a sole proprietorship. Income received by the business passes through to the owner, who will then record it as self-employment income on their individual tax returns. This is called pass-through taxation. While single-member LLCs get the same tax status as a sole proprietorship by default, the way they pay taxes can change. 

Members of an LLC are not considered to be employees, so the income they receive from the LLC is recorded as self-employment income, just like a sole proprietorship. You don’t receive a W-2 from an LLC that you have ownership in. 

Multi-Member

Multi-member LLCs are similar to partnerships in how they’re taxed. It’s essentially the same as a sole proprietorship, but with multiple owners. The LLC itself doesn’t pay income taxes, passing the income to the members instead. Each member pays taxes on the income they receive from the LLC on their own tax returns. 

What Are the Main LLC Tax Benefits?

LLCs have certain tax advantages for members that set them apart from other US small businesses. These are the main tax benefits for LLCs.

Flexible Taxation

LLCs are not all taxed the same. While there’s little flexibility in how an individual is taxed, LLCs can be taxed in 4 different ways depending on how you register and file. You’re not stuck with one way of filing taxes forever and can change your tax type by filing the correct paperwork with your LLC’s state. 

You Can Choose The Way You Are Taxed

LLCs allow you to choose how you’ll get taxed. You can choose for the LLC to be a pass-through entity, also called a disregarded entity, that allows you to claim that income on your own returns, or you can opt for corporate taxes. When the LLC is first formed, tax status can be changed from default to corporate taxation. However, if you elect to change your tax status, you must wait 60 months (5 years) to change your status again.

This choice is advantageous since you can choose a tax strategy that reduces your overall tax burden. For example, if your personal income tax rate is higher than the corporate tax rate, you may be better suited to corporate federal income taxes instead of pass-through taxation. Those in a low individual tax LLC operating agreement bracket could see more tax advantages from an LLC that passes income through to them. 

If your LLC is taxed like an s corporation or c corporation, you can be subject to double taxation. Double taxation happens when your business pays taxes on income, then you pay taxes again on money that’s paid out to you by your business. Although double taxation is inconvenient, the tax rate for dividends paid out by an s corporation is generally lower than a high earner’s income taxes. 

Business Expenses Deductions

Just as income passes through your LLC and gets taxed as self-employment income, business expenses are also passed to LLC members. As the owner of a single-member LLC, business expenses can be deducted from your individual tax returns. If you’re part of a multi-member LLC, expenses are divided up just like income, with each member able to claim a share on their taxes. These deductions work against your total income, not just the LLC portion of your income.  

LLC owners may also be able to claim Qualified Business Income (QBI) deductions. Not all LLCs are eligible, but those who are eligible can benefit from larger tax deductions. Capital expense deductions may also apply. 

What Are the Disadvantages Of LLC Tax Benefits?

Although there are tax advantages for LLC owners, they’re not advantageous to everyone. Here are a few ways that limited liability companies can put you at a disadvantage on your taxes.

Requiring Self-employment taxes 

When LLC income is claimed on your individual returns, it must be claimed as self-employment income. Self-employment income carries different tax implications than income earned through employment. The main difference is that you are responsible for both the employer and “employee” side of both Medicare taxes and Social Security taxes. Social security and Medicare taxes are required, even if you are a small business owner. 

Employers normally pay half of these taxes, with the other half withheld from the employee’s pay. These are called payroll taxes, and your LLC will pay them for other non-member employees. With self-employment taxes, you are fully responsible for the entirety of these taxes. Taxes will not be automatically deducted from your income, so you also need to pay these mandatory taxes on a quarterly basis. 

All profits are taxed even without income

Profits are automatically distributed to LLC members, whether there is any tangible income associated with the business’s profits or not. All non-deductible profits become part of your taxable income, which is problematic if you don’t have real cash income from the LLC. 

Tax deductions do help reduce this burden, but only to an extent. Depending on what your individual tax situation is, pass-through taxation from a Limited Liability Company can be difficult to navigate for small business owners. 

Additional state taxes and fees

In some states, LLCs will be responsible for extra taxes and fees. These are dependent on state laws that may place an extra burden on LLCs to support a public program or function in that state. California, for example, charges an annual tax of $800 for all registered LLCs in the state, whether they are currently doing business or not. Taxes like these can put a strain on both your business and your personal finances, as income and tax burdens are passed along to members. 

General LLCs Tax Deductions

An LLC is able to deduct many business expenses to reduce the tax burden placed on members. Most expenses that are related to operating the business or supporting employees of the business are tax deductible, but the specific deductions available to your LLC will vary based on the state you’re registered in.

Here are some of the main tax deductions most LLCs can access throughout different US states. 

Qualified Business Income deduction (QBI)

LLCs that are taxed as pass-through entities can access qualified business income (QBI) deductions. This deduction allows self-employed individuals and small business owners to deduct up to 20% of their business income from their taxes.

In general, QBI deductions come out of your business’s net profits, not from other sources of income you receive from your business. You cannot apply QBI deductions to dividends, capital gains, interest income, or income earned outside the US.

Depending on your total income within the tax year and your personal assets that are taxable, you may qualify for the full 20% deduction or partial deduction. QBI is determined on an individual basis on your tax return, not based on the business itself. Your total income includes income from all other sources, although the QBI deduction would only be applied to the ordinary income from the business.

Not all businesses are eligible for QBI, but it’s worth checking if your business is eligible. 

Health insurance

Some payments for health insurance premiums for you, your dependents, and employees of your LLC can be deducted from your business income, which will carry over to your personal income tax return. If the business pays for healthcare for you, deductions may be taken differently, but they can still apply.

Disability insurance

Some disability insurance premiums paid by your LLC may be tax deductible. Generally, premiums have to be paid on behalf of your LLC’s employees to be deductible on your taxes. Specific states may have their own standards for qualifying disability insurance payments. 

Office supplies and connectivity

Office supplies used for your business within the year they were purchased can be deducted on your taxes. All office supplies are deductible, including paper, pens, printer ink, business software subscriptions, computers, and more.

This deduction also includes services you pay for to access utilities like the internet or phone service. Internet service that’s used for your business is usually tax deductible on your personal tax return. 

Charitable donations

When your LLC is a pass-through entity, charitable contributions your LLC makes can be tax deductible. Only contributions made to qualifying organizations can be deducted, or donations made to unqualified organizations for specific public-interest projects. 

Home office

If you work from home and have a dedicated home office space, you can get a tax deduction for that space. There are restrictions to this, such as the space having to be used primarily for your work, with certain types of work excluded.

Home offices can be deducted using a standardized rate of $5 per square foot for the workspace, or by measuring what percent of your house your office takes up. This deduction applies to LLC members because it’s taken from your individual tax returns, which means you can apply it to your self-employment income. 

Business vehicle and mileage

If you use your personal vehicle for work, there is a tax deduction available for any mileage used for business purposes. You can’t claim all usage of your vehicle on your tax returns, but you can claim the mileage used for business as an expense. 

Special Tips Of LLC Taxes For Business Owners 

As a business owner, you can tap into LLC tax benefits to optimize your personal tax situation and reduce your tax burden as much as possible. As the only business entities in the US that allow you to choose how you get taxed, LLCs offer a unique chance to take charge of how you’re taxed and get ahead of difficult tax bills.

Look at your tax situation carefully before you elect to have your LLC taxed as a corporation. Once you make this election, you can’t change it again for the next 60 months. If you want to change it before the 60-month period is over, you can make a request to the IRS for an early status change, which will then be accepted or rejected based on your reason for making the request.

If your LLC is small and you or the other members are in low tax brackets, the default tax status may be more beneficial to you than corporation taxation. However, as your business grows and its income increases, or as your own personal income grows, you can elect to change your LLC’s tax structure to allow for a more beneficial tax arrangement. This is because corporations can retain earnings instead of passing them through to members. Additionally, dividends are taxed at a lower rate than most self-employment income. 

Does It Fit Your Business?

Not all LLCs are structured the same way. Depending on the state they’re formed in, there may also be different regulations governing how an LLC is taxed. It’s important to check what tax structure and deductions apply to your LLC before you make any assumptions.

Take note of how your chosen tax structure will impact your business and personal finances. The unique tax properties of an LLC give you the flexibility to choose how your business income is taxed, so it’s ideal to look at all your options carefully and consult a tax professional before making a choice. This article should not be considered as professional tax advice for you or your business. Contact a law firm or tax advisor with experience dealing in LLC taxation for expert advice on your specific situation. 

Final Thoughts

LLCs have some unique tax properties that can be highly beneficial for members. If you have an LLC or you’re planning to start one, check out the tax benefits that would be available to you and how these LLC tax benefits could impact you. 

Frequently Asked Questions (FAQs)