LLCs also come equipped with limited liability. This creates a separation between personal and professional assets. Limited liability protection ensures that your personal belongings, like houses and cars, are not impacted by unforeseen circumstances that may impact a small business such as a lawsuit or business debt.
One of the biggest benefits of forming an LLC is the ability to save money on taxes. LLCs are a popular entity formation due to their “pass-through” entity status. Here’s what this term means and the impact it has on an LLC’s taxes.
What Does “Pass-Through” Mean for LLCs?
What does the term “pass-through” mean in relation to LLCs?
An LLC is taxed as a pass-through entity by default. This means business profits “pass-through” to the members (also known as owners) of the LLC. From here, members report profits and losses on their individual tax returns.
The pass-through nature of an LLC provides a number of benefits for small businesses that incorporate as this entity formation. Losses and operating costs of the business may be deducted on personal tax returns, helping to offset other income. It also ensures members do not face double taxation since profits and losses are not reported at the business level when filing taxes.
Can LLCs Elect a Tax Designation?
Yes! The flexible nature of an LLC allows entrepreneurs to choose how it would like to be taxed. By default, most single-member LLCs are treated and taxed as sole proprietorships by the IRS. LLCs with more than one member default to partnership status.
LLCs have a wide pool of options available, including C Corporations and corporations, but many often choose to elect an S Corporation for tax purposes.
Advantages of Filing for S Corp Status
An S Corporation is an entity that opts to be taxed under the provisions of Chapter 1, Subchapter S of the U.S. Internal Revenue Code. In practice, this means the company does not pay corporate income taxes. The business income passes through to the individual owners, enabling owners to legally avoid double taxation.
Sounds familiar to how an LLC entity formation works, right? This is what makes it so important to file for S Corp status. When an LLC files for S Corp status, this alerts the IRS how to treat the business for tax purposes. Otherwise, LLCs may be taxed at their default sole proprietorship or partnership status.
Aside from the benefits of pass-through taxes, an S Corp election also comes equipped with liability protection. This entity protects the personal assets of its shareholders, ensuring that they are not seized by creditors to pay back any debts owed by the business. An S Corp’s shareholders are also allowed to serve as employees in the business. This gives them a salary, dividends, and additional compensation that may reduce self-employment tax liabilities.
Getting Started Filing an LLC
Prior to filing an LLC or choosing to elect an S Corporation filing, you may have a few additional questions about the process. While we cannot provide legal advice, we do advise entrepreneurs to first meet with an accounting professional or attorney. They may be able to answer your questions and ensure you are choosing the right entity formation for your business so it may receive these tax benefits.
Deborah Sweeney is the CEO of MyCorporation.com. MyCorporation is a leader in online legal filing services for entrepreneurs and businesses, providing start-up bundles that include corporation and LLC formation, registered agent, DBA, and trademark & copyright filing services. MyCorporation does all the work, making the business formation and maintenance quick and painless, so business owners can focus on what they do best. Follow her on Twitter @deborahsweeney and @mycorporation.Join MyCorporation's Partner Program
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