In this article, we will explain the tax advantages of an LLC and how they work.
Let’s get started.
1. Startup Cost Deduction
When we register an LLC, we can deduct startup costs, including all expenses incurred before registration.
For example, materials you may have needed, licenses, courses, etc.
Another example is if you are an employee and gradually buy your materials. These expenses are declared in your first tax return.
According to the IRS (Internal Revenue Service), in the first year, you can deduct up to $5,000 for startup costs and $5,000 for organizational costs (papers, procedures, etc).
If your expenses exceed these amounts, the remainder will be deducted over a period of years.
2. An LLC is also considered a Pass-Through Entity
An LLC that pays as a sole proprietorship, partnership, or S Corp does not pay taxes itself. Instead, the net income or loss passes through to the owner, and it is the owner who must pay taxes.
Then we have other tax election types where double taxation applies, such as the C Corp.
So if we have an LLC that elects to be taxed as a C Corp, the C Corp pays taxes at the corporate level, and then taxes must be paid on certain distributed profits.
3. Tax Flexibility
The second tax advantage of an LLC is that it can choose how it wants to be taxed or pay its taxes.
It can pay taxes as:
- Sole proprietorship.
- Partnership or association.
- S Corporation.
- C Corporation.
Like everything else, there are advantages and disadvantages to each choice. So, to make a decision, you should consider the nature of your business activities.
Because there are different types of income: passive and active.
- Passive: recurring income that does not require specific work, for example, renting properties.
- Active: income generated when selling a product or service, the result of physical and/or mental effort.
Each type is subject to different tax rules.
Depending on the tax election you choose, your tax obligations will vary.
For example, for an LLC that will pay taxes as a sole proprietorship or a partnership, they must pay self-employment tax and income taxes. This applies when their business activities generate active income, such as a restaurant.
But if their income is passive, those net rental profits are only subject to income tax.
In an LLC that elects to be taxed as an S Corporation, net profits only pay income tax for active income.
For an LLC that elects to be taxed as a C Corporation, net profits will be subject to corporate tax, which is 21%. If owners or members distribute profits, they must pay taxes based on the money they received. The percentage will depend on the size of their family and the income they generated.
We understand that this topic can be somewhat extensive and complex, which is why at Rex Legal, we offer guidance for every step of the process when establishing your business in the USA.
If you need guidance, contact us.
4. Tax Advantages Regarding Medical Expenses
Depending on your business’s tax election, you may benefit from these advantages.
An LLC that is taxed as a sole proprietorship can deduct medical expenses from taxes, as long as the LLC is generating profits.
If your Limited Liability Company pays taxes as an S Corporation, you can deduct medical expenses as long as those expenses are reported on a W-2.
And for an LLC taxed as a C Corporation, owners can deduct medical expenses, even if the company is in a loss position.
5. Eligibility for a Qualified Business Income (QBI) Deduction
LLCs that elect to be taxed as sole proprietorships, partnerships, or S Corporations may qualify for a QBI Deduction, which amounts to a 20% reduction in taxes on profits.
There are some conditions to meet to qualify for this tax deduction, but once you do, it becomes another one of the advantages.
Need Guidance? Rex Legal is Here
As mentioned earlier, we understand that this topic can be extensive and confusing for some individuals.
So, if you need personalized guidance to help you navigate through each of the processes, simply contact us.