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What are the tax benefits of opening an LLC?
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When starting a business, one of the key decisions you need to make is how you’re going to structure your company.
For many entrepreneurs, a limited liability company (LLC) offers an ideal balance of flexibility, tax benefits, and legal protection. But what is an LLC? How does it differ from other business structures? And what exactly are the benefits?
In this article, we’ll cover all the bases, including the key advantages, the tax perks, and the steps to get started.
Jump straight to a key chapter
What is an LLC?
A limited liability company — or LLC — is a flexible business structure that combines elements of the corporation and sole proprietorship models. Under this structure, owners (called "members") are protected from personal liability, meaning your personal assets are generally safe from business debts or lawsuits.
At the same time, it allows for a simpler operational structure compared to traditional corporations.
What are the different types of LLC?
LLCs come in various forms tailored to specific needs, such as:
Single-member LLC: Owned by one person, offering simplicity and liability protection.
Multi-member LLC: Owned by two or more individuals or entities.
Series LLC: Contains multiple “series” or divisions within a single LLC, each with separate liability.
Manager-managed LLC: Run by appointed managers instead of all members.
Member-managed LLC: Operated by the owners themselves.
What is the difference between LLCs and corporations?
While both structures provide liability protection, their suitability is dependent upon the size of your organization.
An LLC offers more flexibility in terms of management and taxation, and is more suitable for small to medium-sized businesses.
Conversely, a corporation often has stricter rules and is liable for double taxation (unless it opts for S-corp status).
What are the tax benefits of an LLC?
One of the key reasons entrepreneurs choose an LLC is the range of tax advantages it offers. From pass-through taxation to potential self-employment tax savings, LLCs provide flexibility that can result in significant financial benefits. These include:
Pass-through taxation
LLCs are taxed as pass-through entities by default, meaning the business itself doesn’t pay federal income taxes. Instead, profits and losses “pass through” to the members, who report them on their personal tax returns. This avoids the double taxation that corporations face, where income is taxed at both the corporate level and the individual level when distributed as dividends.
For example, If an LLC earns $100,000 in profit, that amount is divided among the members based on their ownership percentages, and taxed only once on their personal tax returns.
No corporate taxes
By default, LLCs sidestep the federal corporate income tax, which can be as high as 21% for C-Corps at the corporate level before dividends are taxed again at the shareholder level. For small and medium-sized businesses, avoiding this additional layer of taxation can lead to significant savings.
Tax flexibility
LLCs are uniquely flexible in choosing how they are taxed. You can opt for:
Default taxation: Single-member LLCs are taxed as sole proprietorships, while multi-member LLCs are taxed as partnerships.
S-corp election: LLCs can opt to be taxed as an S-corp, which can reduce self-employment taxes for owners who actively participate in the business.
C-corp election: If your business is planning to reinvest profits heavily or attract institutional investors, electing C-Corp taxation may offer strategic benefits, such as access to certain tax deductions and credits.
Self-employment tax savings
Members of an LLC are generally subject to self-employment taxes on their share of the LLC’s profits, which includes Social Security and Medicare taxes (at approximately 15.3%). However, by electing S-Corp status, members who are actively involved in the business can pay themselves a reasonable salary subject to self-employment tax while taking additional profits as distributions, which are not subject to these taxes.
For instance, if your LLC earns $100,000 in profit and you pay yourself a salary of $40,000, only that $40,000 is subject to self-employment tax, potentially saving thousands.
Deductible business expenses
LLC members can take advantage of numerous tax deductions, reducing their taxable income. Common deductible expenses include:
Startup costs
Health insurance premiums
Retirement contributions
LLC insurance costs
Home office deductions
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Qualified business income (QBI) deduction
Under the Tax Cuts and Jobs Act (TCJA), LLC members may be eligible for the qualified business income (QBI) deduction, which allows a deduction of up to 20% of the LLC’s net income. This deduction applies to pass-through entities and can significantly reduce the tax burden for LLC members, depending on your income level and business type.
Flexibility for multi-member LLCs
In multi-member LLCs, profits and losses can be distributed in a way that isn’t directly tied to ownership percentages. This allows members to take advantage of tax strategies tailored to individual financial situations, as long as the allocation is outlined in the LLC’s operating agreement.
For instance, if one member is in a lower tax bracket, a greater share of the profits could be allocated to them to reduce the overall tax burden for the group.
State tax advantages
Some states offer tax advantages for LLCs, such as lower franchise taxes or exemptions from certain business taxes. For example, some states impose no state-level income tax on LLCs, further reducing the tax burden.
Simplified tax filing
LLCs generally have simpler tax filing requirements compared to corporations. Single-member LLCs file taxes as part of the owner’s personal tax return using Schedule C, while multi-member LLCs file Form 1065 and provide members with a Schedule K-1 for their share of the profits.
What are the other advantages of an LLC?
LLCs are popular for a multitude of other reasons, including:
Limited liability protection
One of the most significant benefits of an LLC is that it protects its members’ personal assets. If the business incurs debts or is sued, members are typically not personally responsible. This means creditors cannot go after members’ personal property, such as homes or savings, as long as the business maintains proper separation between personal and business finances.
Operational simplicity
As mentioned, LLCs require fewer formalities than corporations. There’s no need for a board of directors, annual shareholder meetings, or extensive record-keeping. This makes managing an LLC much more straightforward, especially for small business owners who want to focus on running their business rather than navigating red tape.
A flexible management structure
LLCs offer complete flexibility in management. For instance, members can choose to set up:
A member-managed LLC, where all members participate in the day-to-day management and decision-making.
A manager-managed LLC, where members appoint one or more managers to handle the operations. This can be helpful for larger businesses or passive investors.
This adaptability allows your business to design a management structure that works best for your specific needs.
Credibility and professionalism
Establishing an LLC can enhance your business’s credibility. Operating as an LLC rather than a sole proprietorship or partnership demonstrates professionalism and can make the business more appealing to clients, investors, and partners. The “LLC” designation in your company name signals that your business is a legally recognized entity.
What are the disadvantages of an LLC?
Despite its benefits, an LLC isn’t perfect. It’s important to consider the following:
Self-employment taxes. As mentioned, members must pay Medicare and Social Security taxes on all profits, unless you opt to be taxed as an S-corp.
Cost. Starting and maintaining an LLC can be more expensive than a sole proprietorship.
Complexity for multi-member LLCs. If you want to operate a multi-member LLC, you will likely need to create an operating agreement to outline the roles and responsibilities.
Why is an LLC operating agreement important?
An LLC operating agreement outlines how the business is run, detailing roles, responsibilities, and profit distribution.
Specifically, it outlines:
The exact roles and responsibilities of all members.
How the company’s profits and losses will be distributed.
The process for adding or removing members.
The rules for resolving disputes.
While not always required, it’s usually crucial for multi-member LLCs.
How to start an LLC
The process of creating an LLC is relatively straightforward, but certain requirements can vary by state. In general, you’ll need to follow these steps:
1. Choose a name
The first step in forming an LLC is selecting a unique and legally compliant name. Consider these factors:
Uniqueness: Your LLC’s name must not be identical or too similar to an existing business in your state.
The inclusion of “LLC”: Most states require that your business name includes “LLC,” “limited liability company,” or a similar designation.
Restricted words: Words like “bank,” “insurance,” or “university” may require additional approvals, or be outright prohibited.
Check your state’s business name database to ensure the name you want is available. You can also reserve the name (typically for a small fee) if you're not ready to file immediately.
2. File the articles of organization
The Articles of Organization (sometimes called a Certificate of Formation or Certificate of Organization) is the document that officially establishes your LLC within the state.
You can usually file online through your state’s business registration website.
3. Designate a registered agent
A registered agent is required for every LLC. This individual or business entity is responsible for receiving important legal notices and government correspondence. Registered agents must:
Have a physical address in the state where the LLC is registered.
Be available during normal business hours.
You can act as your own registered agent, appoint another member of the LLC, or hire a professional registered agent service (which can typically cost around $100 to $300 annually).
4. Obtain an EIN
An employer identification number (EIN), also known as a federal tax identification number, is issued by the Internal Revenue Service (IRS). It’s essential for:
Opening a business bank account.
Hiring employees.
Filing taxes.
You can apply for an EIN for free on the IRS website. Single-member LLCs with no employees may use the owner’s Social Security number (SSN) instead, but having an EIN is often recommended for added privacy and professionalism.
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5. Comply with any additional state-specific requirements
As mentioned, each state has its own unique requirements for LLCs. Depending on your location, you may need to:
Obtain specific business licenses or permits relevant to your industry.
File an initial report or statement of information shortly after forming your LLC.
Publish a notice of formation in a local newspaper (this is required in some states, like New York).
Check with your state’s Secretary of State office or business division for a detailed list of requirements.
6. Open a business bank account
Again, this isn’t always legally required, but even when it’s not, it’s highly recommended. Separating your personal and business finances is crucial for maintaining liability protection and simplifying bookkeeping, and a separate bank account helps build credibility with clients and vendors.
To open a business bank account, you’ll typically need:
Your EIN.
The Articles of Organization.
Your LLC operating agreement (if required).
How much does it cost to start an LLC?
The cost of starting an LLC depends on the state you’re registering in, as well as your specific needs. Typical costs can include:
Filing fees: Anywhere between $50 to $500.
Name reservation: Optional, but around $10 to $50.
EIN application: Free through the IRS.
LLC insurance: Typically $500 to $1,000 annually, depending on coverage.
How can Remote help?
LLCs offer the perfect mix of liability protection, tax benefits, and operational flexibility for many entrepreneurs. While there are costs and complexities involved, the advantages often outweigh the downsides.
However, once you’re up and running, managing your payroll — and your payroll taxes — can create another level of complexity. Whether you’re hiring domestically or abroad (or both!), Remote Payroll can simplify all of this, and ensure that you are fully compliant with all payroll tax requirements in your and your team members’ locations.
To learn more about how we can help your business stay compliant — and save you time, money, and resources — speak to one of our team members today.
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