If you’ve recently started a business and formed a limited liability company (LLC), at some point you’ll have to start thinking about taxes. Regardless of how your LLC is taxed, many different items are deductible. It’s important to know which deductions apply to your situation.
How LLCs Are Taxed
LLCs are unique in terms of taxation as their owners have a choice about how an LLC will be taxed. By default, an LLC is taxed like a sole proprietorship if it has one member and a partnership if it has more than one member.
In both cases, business income “passes through” to the members, while profits and losses are reported on their individual tax returns. The LLC itself is not taxed, which simplifies the process for members. Also, losses and operating costs of the business can be deducted personally by the members. Taxes are paid at the personal tax rate of the members, although the owners may also have to pay self-employment taxes.
Note that a multi-member LLC must also file form 1065 with the IRS, which is the U.S. Return of Partnership Income. Attached to this will be K-1 forms for each member showing their share of the business income.
But LLCs owners can instead choose to be taxed as a corporation. To do so, the LLC must file a document, referred to as an election, with the IRS. The LLC must then decide if it wishes to be taxed as an S corporation or a C corporation.
C-Corp status means profits are taxed at the current rate for corporations (21% as of early 2022), which is significantly lower than the typical individual taxpayer rate. But keep in mind, C-Corp shareholders, which includes members, must also pay taxes on their distributions (but not self-employment taxes). Thus, the C-Corp is subject to what is sometimes referred to as double taxation.
As with sole proprietorship and partnership status, S-Corp taxation considers the LLC a pass-through entity, which means income passes through the company and into the hands of the owners. At this point, taxes are applied at the same rate as those of individual taxpayers.
S-Corps use Form 1120S to file their taxes, which is used to report the income, losses, and dividends of shareholders. S-Corp shareholders do not pay self-employment taxes, which is the primary advantage of S-Corp status compared to sole proprietorship or partnership.
Generally, S-Corp tax status is beneficial if the company is profitable enough to pay the owners a salary and at least $10,000 in annual distributions so the owners can be taxed as employees and not pay self-employment taxes. It costs more to run an S-Corp than an LLC due to additional bookkeeping and payroll expenses. Thus, the tax benefits should be more than the additional costs for an S-Corp status to make financial sense.
Common LLC Tax Deductions
Here are some of the most common potential tax write-offs that may apply no matter what industry you’re in.
You should be able to deduct what you pay to rent an office or retail space, or other rental, such as a warehouse or production facility. If you work from a home office, you may be able to take a home office deduction for the portion of your home that you use for business.
Insurances considered necessary may be deductible. IRS rules regarding insurance deductions are rather complicated, so you’ll need to check with the IRS or your tax advisor about the types of insurance you have.
Cost of Goods Sold
The costs you incur to manufacture products or to purchase items for resale may be deductible. It’s important to keep track of all the costs you incur to make a product ready for sale so that you can get the maximum deduction.
Cost of Independent Contractors
If you outsource certain services for your company, such as various marketing or IT services, you may be able to deduct what you pay independent contractors as a business expense. You will also need to issue those contractors 1099-MISC forms.
If you purchase property, such as real estate or equipment for the business, you may be able to either deduct the purchase price or take a depreciation deduction. Depreciating the item means that you can deduct just a portion of the item each year, rather than deducting it all at once. This is commonly done with real estate.
If you pay professional licensing fees or have any professional development costs such as for continuing education, you may be able to deduct them.
Meals and Entertainment
Be careful with this one and don’t overuse it or you’ll get the attention of the IRS. You can deduct half of the cost of meals and entertainment that pertain to business outings with clients. Meals that you pay for with employees are generally fully deductible.
Generally, you can deduct charitable donations made by the LLC up to 10% of the income of the LLC.
You can take half of what you pay in self-employment tax as a deduction.
If you just started your business and your total startup costs were $50,000 or less, you can deduct up to $5,000 of your startup costs and $5,000 in organizational costs, which are any costs associated with the legal setup of your business.
Any costs you incur to market your business, including paid ads, business cards, brochures, and the like, can be deducted.
Business Loan Interest and Bank Fees
Most fees and interest that you pay to your bank may be deductible, even credit card convenience fees.
Legal and Professional Fees
Any fees that you pay to your attorney, tax advisor, or other professionals may be deductible.
Business Travel Expenses
If you travel for business purposes, costs incurred may be deductible.
Business Vehicle Costs
Mileage and registration fees on a business vehicle may be deductible.
Basic office supply costs may be deductible.
If you pay utilities in your office or retail space, you should be able to deduct your utility expenses.
As you can see, there are a host of items that you can deduct to reduce your tax burden. You just need to be careful that the deductions you take are allowable. It’s recommended that you work with your tax advisor when preparing your taxes to avoid costly mistakes.