Its fairly common when a new business owner comes to me and says they expect to pay less tax this year because they formed a LLC.
I don’t like to be the bearer of bad news, but often the real answer is that simply forming an LLC does nothing to lower your tax bill.
There are things you can do after you form it, but simply having one doesn’t by itself reduce the taxes you owe.
Why are we talking about this in a finance newsletter?
One way to grow your wealth is to keep more of what you earn and redeploy it to other methods of growing your wealth. More resources at your disposal leads to more resources you can use to grow your wealth.
The less taxes you pay by legitimate methods, means more money in your pocket that you can use for things like contributing to your retirement accounts.
Back to the LLC. An LLC is a legal structure designed more for legal protection when properly used. I am not an attorney, so am not giving any legal advice and you need to consult your attorney for that kind of advice. If you do not have an attorney on your finance team, you should have one and I can help make referrals if needed.
From a tax perspective, if you are a Sole Proprietor, you are in business, you have a business name, but no formal company structure and you report your income and expenses on Schedule C of your Form 1040.
If you form a Single Member LLC (one owner, you), you still report the business income and expenses on Schedule C, so that’s why simply forming an LLC has the same exact tax treatment as a Sole Proprietor and often can be some of the highest effective tax rates.
Your net profit is subject to income tax and the net profit is also subject to Self-Employment tax in addition to income tax and that’s a 15.3% tax rate on top of whatever your income tax rate is.
Sometimes you cannot form an LLC due to industry regulations or other rules, but if you are allowed to do so and your net profit grows to a certain level then you can lower your tax bill by electing to be taxed as an S Corporation.
That’s when you can possibly lower your overall tax bill by thousands or even tens of thousands of dollars each year.
When you legally lower your tax bill, you have more resources available to grow your wealth, so that’s why a recurring theme in my articles and my practice is lower your taxes when you can, to keep more in your pocket and use that to grow your wealth. Proper investment choices are important, but more money to invest and grow is a huge factor in building your wealth.
This article will not get into this S Corporation tax election process nor the break point when it probably makes sense to do that. Ask your tax preparer or financial advisor if they think you qualify.
If they can’t or won’t answer you, then consider scheduling a call.
There are many things to consider as to whether or not to make that tax election and not everyone can or should do it. That may be a future article after tax season if there is enough interest in it.
But a key point is that there are deadlines to make this filing to the IRS. If you are already an operating LLC, you need to send in that application form to the IRS by March 15 to count for this year and there isn’t much time left to do that.
If the IRS grants you permission to be taxed that way, there are many more next steps since you the business owner who could not get a paycheck as a Schedule C tax filer, now are required to get one because in addition to being owner, you are also now an employee and have to do a lot of required things that you would do for other employees.
That’s why while making this request to be taxed like an S Corporation can save you a lot of Self-employment taxes, that choice comes with new costs to comply and at some levels of profitability it just doesn’t make prudent business sense to do that.
The information in this and other articles is intended to be educational in nature only. Not tax, legal or investment guidance for you specifically. Each person’s situation is unique and you must seek appropriate professional guidance that can address your unique situation.
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matt@vwshi.com