When starting a new business, one important factor to consider is how your chosen business structure will impact your taxes. Two of the most common structures for small businesses are limited liability companies (LLCs) and corporations. While both offer liability protection, they have very different tax implications. Here's an overview of LLC and corporate tax rules, filings, deductions, and planning strategies.
Tax Treatment of LLCs
One of the advantages of LLCs is pass-through taxation. With an LLC:
- Profits and losses "pass through" the business to the LLC owners' personal tax returns. The LLC itself does not pay taxes.
- LLC owners pay taxes on their share of business income at their personal income tax rates. This avoids double taxation.
- Tax filings are made on the LLC owners’ personal returns, plus an informational return for the LLC itself (Form 1065).
- Popular deductions like health insurance, retirement plans, and mileage can be taken by LLC owners.
This pass-through treatment makes taxes relatively straightforward for most LLCs. However, self-employment taxes apply to LLC members.
Corporate Tax Implications
Corporations face a different set of tax implications:
- C-corps are taxed at the corporate level. Earnings are first taxed on the business return, then shareholders pay taxes on dividends.
- S-corps avoid double taxation since income passes through to shareholders similar to an LLC.
- Corporations file separate business tax returns (Form 1120 or 1120S). Owners also report corporate income on their 1040s.
- Corporations offer some tax deductions, like fringe benefits, not available to LLCs. But others, like health insurance for owners, are usually not deductible.
- C-corps allow deferring taxes on earnings retained in the company. But these face eventual double taxation.
As you can see, the tax implications of LLCs and corporations can vary significantly. Consult a tax professional to determine the best structure for your business.
Tax Reduction Strategies
Both LLC and corporate structures provide opportunities to minimize taxes through strategic planning:
- Carefully time distributions to owners to avoid spikes in taxable income.
- Offset passive income with passive losses through investment reallocation.
- Maximize retirement funding with 401K and similar plans.
- Deduct travel, meals, and other expenses properly attributable to the business.
- Take advantage of business tax credits like the R&D credit.
- Accelerate or defer expenses to move to lower tax years.
- For C-corps, minimize salary levels subject to payroll taxes.
With some tax savvy planning, both LLCs and corporations can maximize income taxed at lower rates.
The tax differences between LLCs and corporations are significant. As the article articulates, being aware of the tax implications of LLCs and corporations is crucial for making an informed decision when starting a business. With the right entity choice and ongoing tax strategies, you can structure your business to manage taxes appropriately.
