Benefits of LLC Tax Designation

Creating a limited liability company (LLC) is a popular way to organize a small business. LLCs offer owners certain advantages of incorporation while still retaining tax benefits typically reserved for unincorporated partnerships. Unlike C-corporations, LLCs do not automatically face separate corporate taxation, making them a desirable choice for many small business owners.

April Walker, the lead manager for tax practice & ethics at the American Institute of CPAs, emphasized the importance of evaluating the owner's current needs and future plans with a professional when considering different business and tax structures.

Pass-Through Taxation Advantages

LLCs are not taxed separately as businesses by default, being treated as partnerships for income tax purposes. This means that income taxes are passed through to the owner or owners, also known as "members." Reporting income and losses from the LLC on personal tax returns is generally seen as a simpler and more cost-effective process compared to filing as a C-corp.

Income from pass-through entities is taxed up to 37%, but certain qualifying income can benefit from a 20% reduction until 2025 due to the 2017 Tax Cuts and Jobs Act. To qualify for the reduction, individuals must have earned up to $163,300, and married couples filing jointly must have earned up to $326,600, with specific exceptions outlined by the IRS.

Choosing Your LLC Tax Designation

LLC members have three federal tax designation options to choose from, with each state having its own requirements for LLC formation. It's essential for business owners to consult state statutes when forming an LLC, with the following federal tax classifications available: Single-Member LLC, Partnership, and Corporation.

A Single-Member LLC is considered separately from the owner unless another option is chosen, functioning as a pass-through designation. Partnerships, on the other hand, involve multiple owners who share in profits and losses, with taxation being passed through to each member. Corporations are subject to Social Security, unemployment, and payroll taxes, providing flexibility for businesses looking to raise capital or plan for future growth.