Tax Benefits of an LLC
Profits and losses will be passed through to the members – if you want to!
In most types of corporations, such as the C Corporation, the corporation will be taxed as a separate entity and the shareholders will only pay tax on dividends. In an LLC, profits and losses will instead be passed through directly the members (owners) and the company will therefore pay no tax. Since each member is responsible for paying the taxes, each member will also be able to take advantage of deductions. Forming an LLC is a common way of avoiding double-taxation without having to hire an expensive attorney. A Limited Liability Company (LLC) is taxed just like a partnership in this regard, both by the state and on a federal level. The members (owners) will only pay one level of tax.
The S Corporation is another company form where earnings and losses will be passed through directly to the owners, but in most other regards the S Corporation is actually more similar to the C Corporation than to the LLC. An S Corporation is owned by shareholders and you have to arrange annual shareholder meetings and appoint a board of directors. An S Corporation is also more complicated to form than an LLC and the amount of mandatory annual documentation is larger.
Besides taxation, one of the main differences between an S Corporation and a C Corporation is that an S Corporation can have no more than 100 shareholders (owners). An LLC can have an unlimited number of members (owners), just like a C Corporation.
If you decide that you want your LLC to be taxed more like a C Corporation, i.e. if you want the company to be responsible for paying taxes instead of the members (owners), this can be easily arranged. You don’t have to turn your LLC into a C Corporation; you simply have to file IRS Form 8832. This form will make the IRS tax the company directly instead of taxing each member (owners).
Allocation of profits and losses can be disproportional to ownership interests
For most U.S. business entities, it is very important that profits and losses are allocated proportional to ownership interest. Failure to do so can lead to serious tax ramifications or even be illegal. An LLC is however allowed to carry out disproportional allocations of profits and losses and it doesn’t have to lead to serious tax consequences. Generally speaking, the LLC is free to decide on its how profits and losses will be allocated among its members.
Include company debt in your tax basis – if you want to!
Members of an LLC may include company debts in the tax basis of their ownership interests. Doing so is uncommon among LLC members, because it is not a widely known tax benefit of the LLC construction. If you have a business that generates tax losses you can often save considerable amounts of money by converting your business into a Limited Liability Company instead of an S Corporation. For S Corporation shareholders, the option of including corporation debts in the tax basis is very limited.
Decrease taxable income without impacting cash flow
When speaking of tax benefits of an LLC, it is also important to mention the possibility for LLC members of decrease the taxable income without impacting cash flow. It is legal for an LLC to step up the tax basis of its assets when a transfer of ownership of an LLC interest is carried out. The tax bases of the assets can be stepped up to a fair market value and this will of course lead to a larger depreciable basis.
