As a small business owner, you probably already know about many of the benefits that come with forming an LLC. But do you know exactly how and why paying taxes as an LLC will save you money? This can be helpful as you plan your spending and finances for the year. In this blog post, we’ll go over exactly why filing as an LLC can pay off come tax time.
You'll Pay Less in Self-Employment Taxes
Here's the bottom line: When you’re self-employed, you have to pay higher taxes (including Social Security and Medicare taxes) than you would if you worked for someone else.
When you are employed with a company, you only have to foot the bill for half your Social Security tax since your employer pays the remainder. In 2017, this is 12.4 percent on up to $127,200 in income. The same holds true for Medicare taxes, which are 2.9 percent on all income. Together, this comes up to a grand total of 15.3 percent overall. So as a small business owner, you’ll be paying an extra 7.65 percent in self-employment taxes each year.
However, when you form an LLC for your business and elect to have it taxed as an S Corp, you can classify part of your income as salary and part of it as distribution. While you’ll still need to pay self-employment taxes on the portion of your income classified as your salary, you won’t have to pay on the portion that’s classified as a distribution. This can help you net a significant tax savings by electing to file as an S Corp!
LLCs are considered “pass-through entities,” which means all profits and losses are passed through the business, and each partner’s share of the profit and loss is recorded on each individual’s tax forms. This is known as “pass-through” taxation.
If your small business has only one owner, as an LLC you’ll effectively be taxed as a sole proprietor. That means your business won’t technically have to pay taxes, since all your business net income is taxed through the owner’s personal tax return — that's you.
The same goes if your small business is run by multiple members and taxed like a partnership. Your small business won’t have to pay taxes itself, because each partner will pay personal income taxes on the profits passed through to them.
Lower tax rate. Depending on your total income as an owner, you may pay less in taxes as an LLC than a corporation. Once you reach higher levels of net income, this could save you more money in taxes than if your business were a corporation. For instance, the current federal corporate tax rate on $100,000 is 34 percent, while the personal income tax rate for the same amount is 28 percent. As you can see, if you reach a certain income bracket, you'll be paying more in taxes on income as a corporation than as an LLC. That's because as a "pass-through entity," your net business income is taxed through your personal tax return. In that case, paying taxes as an LLC saves you more money than as a corporation.
No double taxation. In some cases, a corporation has to pay taxes on corporate net income and the owner of the corporation must pay tax on any dividend income they receive. As a pass-through entity, an LLC doesn’t have to pay these taxes.
No corporate franchise taxes. Depending on which state you live in, a corporation can be required to pay a corporate franchise taxes. You’ll need to check with the state your business is registered in to see what the requirements are and whether your business falls beneath the franchise tax threshold.
As you can see, forming your business as an LLC and electing to file as an S Corp can save your small business quite a bit on tax payments. If you have more questions about forming an LLC, Incfile can help set up and manage your business while you focus on your products and services. They can also file your business taxes for you so you won't have to worry about what you owe and when.