Why is it smarter to operate a business as a LLC for tax purposes?
No matter the timing, it is important for you to consider which business entity will benefit your small business the most, during tax time. An LLC is specific type of business entity, whereof the federal government provides favorable tax benefits under certain scenarios. This type of structure has become very popular for small businesses.
LLCs are treated as “Pass Through” entities
No matter the size of your small business, the IRS essentially provides the tax benefit of larger companies to businesses that operate as LLCs. The term “Pass Through” relates to the fact that your LLC bypasses all of the taxes at the corporate level. In other words, as a registered LLC, you will not have to pay taxes for your company profits as a business, but you will be required to pay taxes for company profits individually. The taxes are assessed as the profits pass through the corporation down to the LLC’s owners, also called Members. These taxes are calculated by the distributive share of ownership, determined by the percentage profits allocated to each member of the LLC. Typically, these percentages are agreed upon in the LLC Operating Agreement. Each member then pays individual taxes on that amount. This is beneficial for a company, because a corporation pays taxes on profits from the business level, but at the shareholder (member) level.
Retained Earnings- LLC can choose C-Corp Taxation
Retained Earnings are the profits that a company chooses to keep within the LLC. If you are registered as an LLC, you still have the option to be taxed as a C-Corp. This is ideal for a company who expects to retain a substantial percentage of profits. Operating your company as an LLC, you can elect to be taxed as a C-Corp and receive the benefit of a 15% tax on the first $50,000 that is earned. 15% is a very low tax bracket for small businesses. It is a lower tax bracket than personal income taxation, which will give you more money to put back into your company.
Other ideas to consider
Small business owners must take into consideration the overall impact of their business entity, at present and in the future. Are you looking to take the company public someday? Are you looking to raise money through Venture Capitalists or Angel Investors? Decisions such as these will affect your ultimate decision regarding your legal business entity and the taxes that go along with.