Tax Advantages of an LLC

Tax Advantages of an LLC

Limited Liability Companies are frequently known by the acronym LLC. The Tax Advantages of an LLC vary by the type of tax filing choice made at the creation of the LLC. The advantages are great. Even better they do not have a lot of disadvantages.

How is an LLC Taxed

As a professional tax return preparer I run into a lot of people who are in total confusion. The reason for this is that there isn’t an LLC tax like there is a “corporate tax.”

YOU CONTROL all of the LLC’s tax advantages

The recognized birthplace of the LLC is Wyoming, They were born in 1977. The LLC is the result of combing the genetic material of a corporation and that of a partnership in the test tube of asset protection hopefulness.

When the state of Wyoming asked the IRS how they should be taxed it took the IRS over 20 years to issue a response..

Wyoming expected that the IRS would create a new section of tax law similar to what they did with the Subchapter S Corporation previously. At that time the IRS created a new tax code out of whole cloth. The IRS created a new Tax Code section known as Subchapter S of the tax code. In this writing they outlined how they would tax this new type of corporation.

The IRS Response

As we said it took the IRS took about twenty years to answer Wyoming’s question about how an LLC would be taxed. In summary the IRS said we don’t care how an LLC is taxed. We are tired and have decided not to write any more tax code.

Since the IRS does not care how an LLC is taxed, the owners, partners or managers of the LLC can choose the tax structure of their preference.

An LLC can be taxed as S Corp, C Corp, Partnership or a Sole Proprietorship. All you need to do is pick one within the time frame allowed by the IRS.

Corporate Tax Preference Checklist

It is the LLC’s obligation to tell the IRS how it wants to be taxed.

1. Obtain a tax ID number from the IRS using Form SS4.

2. Pick a tax filing preference

        a. Corporations      

1. File IRS form 8832 within 90 days

                2. For s-corporations also file IRS Form 2553

The tax advantages between a “C Corporation” and a “Subchapter S – Corporation” are very different. They each have varying tax deduction advantages. In our opinion, the tax advantages of an S-Corp are currently greater under the recently passed Tax Cuts and Jobs Act. Just remember that everything changes and this advantage may not last for ever. But neither does an LLC.

An election to have the LLC taxed as an S Corp means the LLC is for all intents and purposes is an S-Corp as far as the IRS is concerned.

First Great Tax Advantage of an LLC

The only tax advantages of an LLC are the tax benefits of the “entity” that the LLC owner chooses to have his LLC taxes paid as.

Limited Partnerships and Subchapter S corporations don’t have access to the great tax benefit of an LLC.

Limited Partnerships and Subchapter S profits and losses need to be “distributed” pro rata to the owners. The distribution is based upon ownership percentage. An LLC permits the manager to make distributions in any proportions to the owners, not on a pro rata basis

Do you want to shift income to the children and grandchildren? Does a family member have an immediate need for funds due to illness or injury? The manager can make that decision.

The Second Great Tax Advantage of an LLC

Managers of an LLC can pay themselves a “reasonable wage” and then take the rest of the “profit” as a distribution. Distributions are taxed as passive income and are not subject to self employment tax like “reasonable wages are”. Distributions will save between 5 and 7 percent of the cost of self employment tax.

The Third Great Tax Advantage of an LLC

An LLC can set up contributions to Retirement Plans. Make sure your initial LLC operating agreement allows the establishment of self directed retirement plans.  The reason for this is once you are established and making a profit the ability to defer taxes to lower income producing years is critical. Notice I said defer. Except for Roth plans all distributions from retirement plans are subject to the tax existing at the time of withdrawal. We will have future posts about Qualified Retirement Plans or QRPs in the near future,

IRS Automatic Status

If you fail to chose a tax status preference the IRS will be glad to choose one for you.

If you do nothing when you set up your LLC and are a sole owner single member LLC the IRS will tax you as a sole proprietor.

On the other hand if you are a “partner” then your LLC taxes will be by default set as a partnership by the IRS.

Late Filing Penalty

Several of our students have been to Spend your money here the GURU is in town fortune busting seminars. On average the paid $6,000 to purchase an LLC package. They never get the tax advice needed to avoid the IRS penalties. Currently failing to file a multi-member LLC income tax return by March 15th results in a penalty of $195.00 per month per partner.

Caution

There are numerous courses and downloads for the perfect LLC operating agreement. These are great tools for educating and discussing the topic of LLCs. NEVER use them unless they have been reviewed by your attorney.

We use LegalShield for all of our legal needs. For more information go to www.Skidis.Biz or send me an e-mail.

Good Luck and Good Investing

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