Common misconceptions about LLCs and their ability to save you tax
There are many posts on social media where non-tax professionals rave about setting up an LLC. When starting a business, it is always best to speak with a professional. Many factors should be considered when deciding to form a business; the tax part is important but isn’t always the most important. If you start an LLC and you are the only owner, then on the federal side, there are no tax savings to be had, as the business would be treated the same as a sole proprietorship. For state purposes, it depends on where you form the business (as well as any other states you have a filing requirement), as each state has different rules regarding how single-member LLCs are treated. For example, in California, they treat your single-member LLC as a separate entity, so you will file a California tax return and pay California minimum taxes and, depending on your income, California LLC fees as well. You also have to deal with the organizational cost and ensure that you are treating the business as a business. However, if your primary goal of setting up an LLC is to have that extra liability protection, it might be beneficial for you (although that liability protection can be limited in certain instances). Again here, you want to look to your state for the rules they have that govern LLCs. In California, if you are a licensed professional, you may not be eligible to form an LLC. In other states, they have PLLCs for professional LLCs, but California doesn’t have that option.
Now let’s assume you have a partner and form an LLC; in this case, the LLC will be treated as a separate entity, and then there is more potential to save on taxes. As a single-member or multi-member LLC, you can elect to file as an S corporation. Electing to be taxed as an S corp has many benefits, especially as a single-member LLC, but it also comes with certain drawbacks. S corp owners are required to take a reasonable salary, so you have the added cost of needing payroll; if you already have employees, then there may not be much extra here. You also have the added cost of tax preparation for the S corp (if you are a multi-member LLC, you would already have the cost of a separate return). While these extra costs are deductible on the business return and, in turn, help you save on taxes by reducing the net income that flows through to your individual return, the added administrative burden may not equal the potential tax savings.
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