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Taxes are a pain. This burden can feel like it’s amplified when you form an LLC.
Fortunately, this in-depth guide will explain everything you know about how LLC taxes work, including tips and strategies for LLC taxes.
Why LLC Taxes Are So Important
Let’s start with the obvious—every LLC needs to file and pay taxes on income.
Taxes are paid at the federal, state, and local levels, and there’s a wide range of potential tax categories that LLCs might be responsible for. Examples include payroll taxes, sales tax, self-employment tax, and more.
Failure to report, file, and pay the appropriate taxes to the right agency can land your LLC in hot water. You could be hit with fines, penalties and run into other issues for non-compliance.
For example, the state might not issue your LLC a certificate of good standing if your LLC taxes aren’t in order. This could prevent you from obtaining a loan, entering a contract with a potential partner, securing financing from an outside investor, or restrict you from conducting dozens of other business-related tasks.
The unique part about LLC taxation is that, unlike other business entities, LLCs have flexibility with how they get taxed. In simple terms, you have several options to consider.
By default, LLCs are treated as a “pass-through entity,” meaning the LLC itself doesn’t actually pay taxes. Instead, the LLC members (owners) pay taxes on their share of the profits on their individual tax returns. However, LLCs have the option to be taxed as a corporation instead of a pass-through entity.
Each scenario has pros and cons, and the best option truly depends on the LLC in question. Whether you’re running a single-member LLC, multi-member LLC, what state or states you’re operating in, and whether or not you have employees are all examples of factors that will play a role in the best tax strategy for your LLC.
But once you understand how LLC taxes work, it’s relatively easy to find the best taxation strategy for you and your business. This will help reduce your tax burden and ensure you remain compliant.
Here’s an interesting case study on LLC taxes that shows how the right taxation strategy can save a lot of money on taxes.
The company in this particular example owns the rights to computer software. It’s a partnership expecting to generate $900,000 per year with $300,000 in expenses, resulting in a $600,000 net profit before the owners get paid.
After consulting with a CPA on the right tax strategy, they determined that getting taxed as a C corporation wouldn’t make sense because the company’s net profits were too high and would ultimately result in higher taxes for the two partners.
The CPA ultimately suggested a multiple LLC strategy, where each partner would separately own their own LLC. Then these two LLCs would jointly own the initial computer software company, giving each partner the best liability protection and tax savings options.
Quick Tips For Navigating LLC Taxes Today
Follow these quick tips and best practices explained below to simplify your filings and save money on taxes. While it will always be in your best interest to consult with an accountant, these are reasonably easy to understand and implement, even if you’re a complete beginner.
Tip #1 — Take Advantage of Accounting Software
The IRS and other tax agencies don’t make things easy when it comes to calculating taxes. Trying to figure out exactly how much you owe and when you owe it can feel like you’re about to perform brain surgery.
Even if you manage to get everything right, it will likely take you a ton of time if you’re doing this manually. Your time can be better spent working on other aspects of your business.
But accounting software really simplifies things for LLCs. Tools like QuickBooks help you prepare for tax time to maximize deductions.
While QuickBooks won’t necessarily tell you which taxation method works best for your LLC, it keeps everything organized so you and your accountant can confidently make this decision. You can use it to track expenses, automatically sort expenses into the right category, and share reports with your accountant.
For those of you operating an LLC that’s subject to sales tax, QuickBooks makes it easy to track this for you as well.
QuickBooks has an excellent self-employed plan that’s perfect for single-member LLCs. The software will automatically calculate your quarterly tax estimates so you can pay your tax liabilities with confidence.
They also offer advanced self-employment tax bundles that include a state tax return, a federal tax return, an on-demand CPA, tax advice, and more.
The self-employed plans start at $7.50 per month, and the small business plans start at $12.50 per month. You can try QuickBooks for free with a 30-day trial.
Tip #2 — Elect For C Corp Taxation
Getting taxed as a corporation can be beneficial to many different types of LLCs. With a C corp election, it can simplify things for you as well.
For income tax purposes, a C corp is considered a separate entity from its owners. In this scenario, profits and losses from the LLC aren’t passed through to individual tax returns of each owner. Instead, the LLC will pay income taxes on its net profit for the year at the corporate tax rate.
After the 2017 Tax Cuts and Jobs Act went into effect, the corporate tax rate dropped from 35% down to 21%.
The 21% flat rate is lower than four other tax rates imposed by the IRS. This makes it very appealing for LLCs to be taxed as a C corporation.
You won’t pay taxes on the LLC’s earnings on your personal returns unless you actually receive compensation. This gives you a little more control over how much you’re taxed on your individual returns.
The downside of this method is that you’re faced with double taxation. That’s because the income you receive has already been taxed by the LLC’s corporate rate, and then you’ll pay taxes again on your personal return. With that said, this can still result in less taxes owed for LLC owners in certain tax brackets.
Tip #3 — Use S Corporation Tax Status to Save on Self-Employment Taxes
Self-employment taxes are a significant burden to many LLC owners nationwide. The self-employment tax rate is 15.3%, comprised of two parts—12.4% from Social Security and 2.9% from Medicare.
Regular employees pay Social Security and Medicare taxes, but they pay these taxes at a lower rate, as their employer matches contributions. Self-employed individuals are responsible for paying the full 15.3% on their own.
The tricky part about self-employment tax is that the number is based on net income—not taxable income. So by default, LLC members are responsible for paying self-employment tax on net profits received from the business.
If you’re running a single-member LLC and the business has $100,000 net profit on the year, you’ll owe $15,300 in self-employment taxes with the default LLC tax structure. Then you’ll still owe additional federal, state, and local income taxes.
The simple solution? S-corp tax election for LLCs.
This allows you to control which portion of your compensation is subject to self-employment tax.
Let’s stick with the same $100,000 net profit example to explain how this works. You could pay yourself a $50,000 salary and an additional $50,000 as distributed dividends. In this case, you’d only pay self-employment taxes on the salary end of your income, cutting your self-employment taxes in half.
There is some slight risk involved with this, as the IRS looks for signs of potential abuse in the system. Let’s say your LLC made $500,000 in net profit, but you only paid yourself a $20,000 salary. The IRS would likely say that’s unreasonable.
While there is some gray area in terms of what’s considered reasonable, you should be fine as long as your salary falls into an average range of other people with your job description.
Long-Term Strategies For LLC Taxes
In addition to the quick tips mentioned above, there are a few long-term strategies that will help you save money on LLC taxes. These require a bit more effort on your end, but the payoff will ultimately be worth it.
Strategy #1 — Invest in Your Own Company
This strategy works really well if you’re an LLC getting taxed as a C corporation. In this case, you’re paying a flat corporate tax rate on business income, and your personal tax liabilities are only subject to your actual compensation.
If you want to grow your business over time, you can keep money in the company instead of paying it out to yourself.
Pay yourself a modest salary and put everything else back into the business. You can use any business expenses to lower the net income of the LLC, and you’ll have more control over the taxes owed on your individual return.
As long as the money stays in the business, it’s only taxed once at the corporate tax rate. Continue to reinvest in the business over time if you’re focused on growth. As the company scales, you can increase your salary year over year, then re-evaluate your tax strategy at a later time.
This is also an appealing strategy if you plan to build up the value of your LLC and eventually sell the business.
Strategy #2 — Prepare For Quarterly Estimated Taxes
This is a really common mistake made by new LLC owners. If you’re used to being an employee, you don’t worry too much about income taxes. Taxes are withheld from your paychecks, and maybe you owe a little more or get a return in April.
But LLCs have to pay quarterly taxes.
So while the balance of your business checking account might be increasing with each deposit, you need to recognize that not all of that money is yours to keep—taxes haven’t been paid yet.
Quarterly estimates are due by the following dates each year:
- April 15 — For January 1 – March 31 income
- June 15 — For April 1 – May 31 income
- September 15 — For June 1 – August 31 income
- January 15 — For September 1 – December 31 income
Failing to plan for quarterly estimates can put you in a position where you fall behind on tax payments.
For example, let’s say your LLC profits $50,000 in Q1. You’re in an LLC partnership, and your share of the profit is $25,000. If you spend the full $25,000, you’ll have nothing left to pay the quarterly taxes you owe by April 15.
Quarterly tax planning can be challenging for LLCs with variable income. That’s why it’s so helpful to use accounting tools like QuickBooks, as the software will automatically calculate your quarterly estimates.
Strategy #3 — Start With the Default LLC Tax Structure Before Making Changes
If you’re just starting an LLC, it can be tempting to dive right into one of these tax strategies from day one. But there’s nothing wrong with starting out using the default LLC tax structure in your first year or two.
While this may not give you the best tax advantages right away, it keeps things simple and lets you evaluate a clear path moving forward.
It’s tough to estimate net income and profits if the company is just starting. But after a few years, an accountant will have much more information to work with before recommending a tax plan.
Electing to be taxed as an S corp or C corp doesn’t automatically come with tax savings. For some of you, the default pass-through structure will be just fine. So wait it out before you make a decision.
The first thing you need to do is talk to an accountant. We’re not CPAs here at Crazy Egg, and we can’t give you actual tax advice for your specific business entity.
While the tips and strategies mentioned in this guide can definitely help you learn, you’ll need an accountant to verify the best course of action for your LLC.
One thing we can recommend with confidence is accounting software. QuickBooks and other tools on the market will make your life easier when it comes to navigating the waters of LLC taxes. Check out our guide on the best accounting software for the top options on the market.