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How can I avoid paying taxes for my LLC?

incnow.com - LLC Tax Benefits, Deductions & Loopholes: 10+ Tips To Know

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A general Corporation making a Subchapter “S” Election or an LLC with or without a Subchapter S Election pays no federal tax on its taxable income and no employment taxes on its distributions to stockholders. The stockholders of a Subchapter S Corporation and stockholders of an LLC are taxable on their pro rata share of the taxable income of a Subchapter S Corporation or an LLC reported to them on a Form K-1 whether or not the taxable income is distributed. This is referred to as “passed through business income” which up to 20% may be deducted for tax years 2018 through 2025 subject to the limitations in the Tax Cuts and Jobs Act. The deduction may be taken whether or not the individual taxpayer claims deductions or takes the standard deduction. Listed below are a few important highlights from this Tax and Legal Tips roadmap. Click on the [Learn More] links to read more about these points (in later sections of this page), or scroll down to learn about other tax tips.

The “Limited Liability” of Both Entities

The owners of a sole proprietorship or general partners of a partnership are not protected from the judgments against and liabilities of the business or from the acts of their business partners. The stockholders of Corporations and members owning units in Limited Liability Companies (LLCs), on the other hand, benefit from “limited liability.” In other words, their liability is limited to their investment in the stock of the Corporation or in the units of the LLC. An LLC gives the greatest tax flexibility. The LLC operating agreement includes management provisions and buy-sell provisions, making the LLC a popular entity to own real estate, boats, and airplane, and a popular entity for foreign citizens to render services or sell products. A one-member LLC starts out being taxed as a sole proprietorship. All income and expenses “pass through” to be reported on schedule C of the individual tax return of the member. No EIN (Employer Identification Number) is necessary. A multi-member LLC starts out being taxed as a partnership that needs to apply for an EIN on Form SS-4. Each year, a Form 1065 Partnership Return needs to be filed with a Form K-1 for each member listing the income or losses to be reported by each member.

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The main disadvantage for owners of an LLC that is taxed as a sole proprietorship or partnership is that all taxable income, which passes through to the owners, is treated as “earned income” and is subject to employment taxes. Therefore, the 15.3% Social Security-Medicare rate applies to the first $128,400 of earned income in 2018 and the 2.9% Medicare rate applies to all earned income in 2018 over $128,400. To avoid this disadvantage, an LLC can make a Subchapter “S” Election by applying for an EIN on Form SS-4 and filing a Form 2553 within 75 days after the date of formation or beginning of a tax year. (Note: only U.S. citizens and U.S. permanent residents can make this election). After deducting reasonable compensation and other business expenses, the LLC’s taxable income is then reported by the member(s) as passive income, rather than earned income subject to Social Security and Medicare contributions. After making the “S” election, the LLC would need to file a Form 1120S Corporation Income Tax Return each year. An LLC may elect to be taxed as a Corporation (a.k.a. “C” Corporation) by applying for an EIN, and then filing a Form 8832 within 75 days after the date of formation or beginning of a tax year. After deducting reasonable compensation and other business expenses, the taxable income of an LLC electing “C” Corporation tax status is taxed at the Corporation tax rates on a Form 1120 Corporation Tax Return to be filed each year. For tax years beginning after December 31, 2017, a permanent change was made in the Corporation to a flat tax rate of 21% on all taxable income. Corporation

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A Corporation is controlled by a majority of its stockholders. A Corporation needs to obtain an Employer Identification Number (EIN) and file a U.S. Corporation Income Tax Return each year.

“C Corporation”

A Corporation starts out as a “C” Corporation for tax purposes. This means that the taxable income (after deductions for salary, business expenses, and depreciation on furniture and equipment) is taxable to the Corporation. The Corporation would only be taxed on income “effectively connected with the United States.” The flat 21% corporate tax rate then applies to the taxable income of the Corporation regardless of its activity. Previously the taxable income of personal service Corporations was taxed at the highest personal tax rate.

Subchapter “S” Corporation

A Corporation owned by one or more U.S. citizens or permanent residents may file a Subchapter “S” Election with the Internal Revenue Service on Form 2553 within 75 days after either the date of incorporation or the beginning of a year. The “S” Election will cause the taxable income of the Corporation to be passed through to be taxed to the Corporation’s stockholders in proportion to their stock ownership. The advantage of the “S” Election for Corporations that render personal services is that the profits distributed as “S” Corporation dividends are treated as passive income, and therefore, not subject to employment taxes. After reasonable salaries are paid for the personal services, the 12.4% Social Security Tax and 2.9% Medicare Tax would not have to be paid on the “S” Corporation’s dividends. The disadvantage of the “S” Election is that deductions for health insurance, disability insurance, automobile, and medical, drug and dental plan reimbursements would be taxable to the “S” Corporation stockholders for whom they are paid.

incnow.com - LLC Tax Benefits, Deductions & Loopholes: 10+ Tips To Know

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