If you run a small business, your 2018 taxes were probably far higher than expected. The reason: The 2017 Tax Cut and Jobs Act significantly modified the tax code. These changes didn’t become evident until Americans filed their 2018 taxes. At their heart, the changes aimed to lower taxes for corporations. While this mostly means bigger companies, forming or modifying an LLC can help reduce your tax burden.
The Pass-Through Structure
The main way that forming an LLC can protect your small business is by transforming your business into what’s known as a pass-through entity. A pass-through entity is a business structure that protects your profits from double taxation. It’s what makes an LLC a more appealing business structure than a C-Corp.
C-Corporations pay taxes at both the corporate level and the personal level, but LLC owners are only taxed at the personal level.
Not only does forming an LLC protect your business from double taxation, but it also protects your personal assets. The difference between personal assets and professional ones can be vague if you run a small business. Consider investments and savings accounts you’ve had since before starting your business as a prime example. By forming an LLC, you protect your personal assets, even if your business incurs serious debts or other liabilities.
An LLC does provide these valuable protections. But if you want to get the maximum tax benefits from this structure, work with an experienced small business accountant. There are a lot of ways to save money on small business taxes as an LLC, and your accountant can ensure you’re taking the right deductions.
A Potential Increase
If you’re considering incorporating as an LLC, there’s a risk you could actually end up paying more taxes than you would with another classification, specifically as a C-Corp. Under the current tax code, corporations get more tax breaks. Meanwhile, LLC operators have to pay the 15.3% self-employment tax. It’s a steep rate, but there’s also a lot less red tape involved in forming an LLC, and it’s less expensive to do.
Incorporating for Deductions
If you want to understand one way unincorporated small business owners are penalized under the tax code, look to deductions. Even though they’re taxed similarly to LLCs — think an unincorporated contractor who files 1099s — they don’t qualify for the new qualified business income deduction. This deduction allows pass-through entities with income below a certain limit to deduct 20% of their business expenses from their personal taxes. While you can still make itemized deductions without incorporating, the process can become more complicated without incorporation.
Additionally, while corporations may get more breaks overall, only pass-through operations like LLCs qualify for this 20% personal deduction.
Choosing a Middle Ground
Even if you incorporate as an LLC, with the right paperwork, you can choose to be taxed as an S-Corporation or C-Corporation. In most cases, it’s most advantageous to be taxed as an S-Corp. They don’t fall under the double-taxation framework, but they do get corporation status benefits.
It’s somewhat complicated to do this. For starters, you need to employ yourself as a W-2 employee, and submit payroll taxes for your own employment. And you can’t cut the pass-through portion of your taxes by paying yourself a below-market rate unless you want to be subject to IRS sanctions.
Running a small business has its pros and cons, and the current tax structure certainly counts against it. However, because you work for yourself, you can maximize the best parts. Boost your earnings, take time off, and pursue your passion. Most importantly, ask your accountant which deductions, retirement contributions, and other strategies can help cut your tax burden.
Small businesses saw the full brunt of the new policies with their most recent filings, and now is the time to adapt.