The 2021 tax season has revealed a myriad of loopholes left behind by former President Trump’s Tax Cut and Job Acts (TCJA) policy. Limited Liability Companies or LLCs can now either register for individual or corporate tax returns. To some extent, this has left LLC business owners in a comfortable position, allowing them to choose on which basis they would enjoy yearly tax returns. Although these loopholes have made it somewhat easier for these business owners to enjoy better tax returns, a UC Riverside-led study has shown that Venture Capital (VC) investors have paid more than $40 billion in taxes if they were organized as an LLC rather than a Corporation. Although VC investors have a lot more in taxes, the majority of them are still somewhat reluctant to invest in LLCs than corporations.
LLCs are more flexible when it comes to taxes, but carry a higher risk for survival and lower investor opportunities when compared to C Corps or S Corps. Federal and local state tax laws have also now been adjusted to offer LLCs a default form of classification depending on the number of people working or directly linked to the ownership of the business. It’s become a minefield for business owners to trek when filing yearly tax returns, as each state upholds regulatory changes to its tax jurisdictions, while at the same time ensuring the business abides by federal laws. Consider some of the following things when forming an LLC:
What is an LLC?
A Limited Liability Company is a newer form of business structure that can offer the owner(s) better personal liability protection and better pass-through taxation than compared to C-Corps, S-Corps, sole proprietorships, and partnerships.
How are LLCs taxed?
Because LLCs enjoy more ‘freedom of choice’ when it comes to taxation the owner(s) can decide how the business wants to be taxed. This can either be as a C Corp, S Corp, partnership, or any other form of business. The owner will generally elect which form of taxation they find most suitable but remember this is per federal and local state tax jurisdictions.
If an LLC has more than one owner, federal laws require it to be taxed as a partnership, and on the other side of the spectrum, an LLC with one sole member will be categorized as a ‘disregarded entity.’ This is where LLC taxes become more attractive because in these instances the purpose for federal income tax does not exist.
Are LLCs considered pass-through entities?
It’s a somewhat double-sided answer, but in some cases, LLCs are considered to be a pass-through entity depending on the form of tax jurisdiction it has elected. A pass-through or flow-through entity will only pay taxes on an individual income tax code, whereas a corporation would pay both on an income and corporation tax code.
How does LLC taxation change from state to state?
Each state still governs its tax regulations, but in many cases, we’ve noticed that some states will abide by a form of ‘federal classification.’ What this means is that state regulators will tax LLCs based on the taxation code they have elected. For example, if the owner has elected to be taxed as a partnership on a federal level, the same form of taxation would be duplicated on a state level. This means, depending on state regulations, LLC owners would not have to pay income tax at all.
LLC tax calculations explained
Some companies such as corporations are taxed doubled, both for revenues and income. Smaller LLC entities are only taxed on personal income, allowing owners to deduct nearly 20% of internal business income. This means tax is only based on the owner’s personal income, rather than the business turnover.
Finding yourself around the complex and treacherous road of annual tax filings has led to the formation of platforms such as Zen Business to help business owners find solutions to multiplex tax issues. Although these sorts of platforms have become extremely helpful in the long run, being up to date with the latest LLC tax regulations is still one of the most important aspects to consider when planning a business formation strategy.