LLC Tax Deductions and
Business Tax Loopholes
*Updated as of November 1, 2023.
Business Tax Loopholes and Deductions For LLCs and Corporations
Saving on taxes is a primary reason why savvy business owners form legal entities for their businesses. Limited liability companies (LLCs) and corporations have access to tax privileges that allow them to pay a lower effective tax rate than businesses run as sole proprietorships.
However, you need to know how to structure your business if you want to maximize your potential tax savings.
A Complete Guide to LLC Taxes and Deductions
Below is our expert summary of the tax deductions and loopholes that business owners must know about. LLCs and corporations can legally lower their effective tax rate by learning these valuable tips. We provide our top tips on:
- Tax and Legal Benefits of Incorporating,
- Corporate Tax Elections: C-Corp. Vs S-Corp,
- LLC and corporation Allowable Tax Deductions,
- And much more.
How is an LLC Taxed?
LLCs offer incredible flexibility when it comes to federal taxes. This is part of what makes the LLC a popular choice for businesses of all sizes.
An LLC starts out as being taxed as either a sole proprietorship or a partnership based on the number of members the company has. However, LLC owners can choose to have the company taxed as C-Corporation or S-Corporation depending on which structure benefits the business most.
How Are Single-Member LLCs Taxed?
Single-member LLCs start out being taxed as sole proprietorships. Businesses with this tax status are also called “pass-through entities”. This is because the LLC does not file its own tax return. The business’s taxable income is “passed-through” to the sole member and gets reported on their personal tax return.
Single-member LLC owners report business income and expenses on the schedule C on their individual tax return. Most business owners obtain an Employer Identification Number (EIN) for their LLC from the IRS in order to separate personal funds from business finances. A single-member LLC can use the sole member’s Social Security Number (SSN) or Individual Tax ID Number (ITIN) as the company’s tax ID number, however, this is not advised.
How are Multi-Member LLCs Taxed?
LLCs with more than one member start out being taxed as partnerships. Partnership tax status is another form of pass through taxation. Business income and expenses are passed down to the individual LLC members and listed on a Form K-1 filed with the Form 1065 Partnership Tax Return.
A multi-member LLC needs to apply for an Employer Identification Number (EIN) from the IRS in order to fulfill its federal tax requirements. A multi-member LLC cannot use the Social Security Number (SSN) or Individual Tax Identification Number (ITIN) of one of its members as the company’s tax identifier.
Why and How Are LLCs Taxed as Corporations?
Sole proprietors and LLCs taxed as pass-through entities (either as sole proprietor or a partnership) have a distinct disadvantage: owners need to pay self-employment taxes.
Business income passed through to LLC members is considered “earned income” and is subject to Medicare and Social Security taxes.
As of 2018, the Social Security and Medicare tax rates are as follows:
- 15.3% taxed from the first $160,200 of earned income in 2023.
- 2.9% taxed from all income over $160,200 earned in 2023.
LLC owners can avoid paying employment taxes by making a corporate tax election with the IRS. The members of an LLC can choose to have the company be treated as a C-Corporation (C-Corp) or an S-Corporation (S-Corp) depending on which structure provides the biggest advantage to the business.
How Can the C-Corp Election Benefit Your LLC or Corporation?
LLCs and corporations can cap their taxable income rate at 21% by making a C-Corp tax election with the IRS. Both corporations and LLCs with C-Corp tax status can keep up to $250,000 without needing to account for their accumulated earnings. This helps the company avoid higher tax rates.
After-tax profits can be used for multiple purposes:
- They can reduce corporate debt, and,
- Provide working capital for business operations or expansion.
This can eliminate the need for a Line of Credit loan.
In addition, the C-Corporation election offers the benefit of income averaging. C-Corps are able to apply Net Operating Losses to two past years or carry them into future years.
What Are The C-Corp Tax Election Benefits For LLCs?
An LLC that makes the C-Corp tax election has its taxable income taxed at the corporate rate. A permanent change was made for tax years beginning after December 31, 2017 that set the corporate tax rate at a flat 21% for all taxable income.
C-Corporations are only taxed on income that is “effectively connected with the United States”. In other words, income earned from sources of business operations located within the U.S.
An LLC can make the C-Corporation tax election by:
- Applying for an EIN from the IRS,
- Filing a Form 8832 within 75 days of the formation date or start of the tax year, and
- Filing a Form 1120 Corporation Tax Return each year.
What Are The S-Corp Tax Election Benefits For LLCs?
When you choose the S-Corporation election, the profits you distribute from the company are treated as passive income. This means you do not have to pay 12.4% Social Security Tax or the 2.9% Medicare Tax on these dividends, once you’ve covered reasonable service-related salaries.
There are some downsides associated with the S-Corp election when it comes to certain tax deductions. S-Corp owners must pay taxes on benefits like health insurance, disability insurance, automobile reimbursements, and medical, drug, or dental plan reimbursements.
An LLC can make the S-Corporation tax election by:
- Applying for an EIN from the IRS,
- Filing a Form 2553 within 75 days of the formation date or start of the tax year, and
- Filing a Form 1120 Corporation Tax Return each year.
The Ultimate Guide to Business Tax Deductions
These are the key tax deductions for LLCs and corporations that every business owners should know about. These key business tax deductions include:
- Charitable deductions
- Health insurance deductions
- Disability insurance deductions
- Business vehicle deductions
- Business insurance deductions
- Home office deductions
- Tangible property deductions
- Retirement plan deductions
- Tax deductions for children
- Business entertainment and meal deductions
- Education and expense deductions
- Longevity and productivity award deductions
- Subscription deductions
- Continuing education and convention deductions
- Independent contractor deductions
Charitable Deductions for LLCs and Corporations
Corporations and taxable-LLCs can deduct up to 10% of taxable income for charitable contributions. Many business owners often wonder about the ins and outs of charitable contributions and how they impact business taxes.
Examples of deductible charitable contributions for businesses include:
- Donations to accredited nonprofits,
- Sponsorship of local charity events, or
- Providing inventory to charitable organizations.
Remember, if a corporation or LLC doesn’t deduct all its charitable contributions in the current year, it can carry them over for up to 5 years.
Health Insurance Deductions for LLCs and Corporations
A C-Corporation or taxable-LLC offers substantial benefits when it comes to health insurance for its owners. The company can fully deduct health insurance premiums for its employed owners, their spouses, and dependents. This means that these payments are not considered taxable income for the employee-owner.
Be aware that insurance provider policies might pose certain restrictions. For example,
- Limited or no health insurance offerings to other employees.
- Restrictions to single coverage.
For context, if a family health insurance plan costs $5,000 annually, an owner might need to earn as much as $10,000 before taxes to foot this bill from their after-tax earnings. Beyond the corporate structure, an individual only sees premium deductions benefits if the total of these and other medical costs surpasses 10% of their adjusted gross income.
Disability Insurance Deductions for LLCs and Corporations
- A C-Corporation or taxable-LLC can buy disability insurance for its executives or other employees.
- The corporation can deduct the insurance premium from its taxes.
- The executive or employee won’t face any tax implications on the premium amount.
A C-Corporation or taxable-LLC can buy disability insurance for its executives or employees and deduct the premium. This allows the executive or employee to benefit without facing any tax implications on the premium amount. However, there’s a potential downside: if an executive or employee later receives insurance benefits due to disability, those benefits will be taxable.
To sidestep this tax on benefits, the executive or employee could purchase the disability insurance directly and cover the premiums. Following this approach, the C-Corporation or taxable-LLC can reimburse the individual at the close of the insurance contract year for the premium cost and claim a tax deduction for that reimbursement. This strategy allows the executive or employee to receive their disability benefits without any tax burden.
Business Vehicle Deductions for LLCs and Corporations
A C-Corporation or taxable-LLC can reimburse an executive or employee for business-related driving in a personal vehicle. Alternatively, the corporation or LLC can buy or lease a business car, with a portion of its personal use—like commuting—reflected in the executive’s or employee’s Form W-2.
A C-Corporation or taxable-LLC can cover transportation costs through:
- Reimbursements: The company can reimburse driving expenses to an executive or employee using the IRS-approved mileage rate for business trips taken in a personal vehicle.
- Buying or Leasing: The company itself can buy or lease a vehicle for business use. If the vehicle has any personal usage, such as daily commutes, this should be noted in the executive’s or employee’s Form W-2.
- Executive or Employee Ownership: The executive or employee can buy the vehicle, claim a business-use-based depreciation, and then lease it back to the company. This method offers flexibility, especially when the executive or employee plans to switch to personal use and get a new vehicle for the business later on.
Business Insurance Deductions for LLCs and Corporations
Business insurance deductions allow corporations and LLCs to reduce their taxable income by the amount they pay in premiums. To claim these deductions, ensure that you purchase the right insurance coverages tailored to your corporation or LLC’s needs.
Tips for Maximizing Business Insurance Deductions
- Consult with your insurance agent to ensure that you have optimal coverage.
- Ensure that the corporation or LLC is always the primary insured on all policies.
- Ensure that Worker’s Compensation Insurance covers everyone in the company.
Consultants who operate through an LLC should consider getting professional liability insurance. Additionally, owners actively working in the corporation or LLC should think about getting an umbrella liability insurance policy and elevate their auto and home policy limits to at least $1 million. Keep in mind, these premiums are fully deductible for corporations or tax-liable LLCs.
Home Office Deductions for LLCs and Corporations
The Internal Revenue Code permits corporations or tax-liable LLCs to cover their employees’ home office expenses. To qualify for home office deductions, employees need to:
- Consistently and exclusively use their home office for the company’s administrative, management tasks, or
- Use their home for storing business records, inventory, or product supplies.
Companies can offer reimbursements for home office expenses monthly or annually. Not only can the business deduct this cost, but the employee doesn’t count it as taxable income. Eligible home office expenses include:
- Homeowner’s insurance,
- utilities, and
- phone bills.
The reimbursement amount relates to the home office’s size compared to the entire home. The IRS approves a straightforward home office reimbursement of up to $1,500, suitable for spaces up to 300 square feet, without itemizing each expense.
While you can claim depreciation for the home office area, remember this gets recaptured when selling the house. To preserve the full long-term capital gain exclusion (up to $500,000 for married couples and $250,000 for singles), consider avoiding home office reimbursements three years before selling your home.
Tangible Property Deductions for LLCs and Corporations
Section 179 of the Internal Revenue Code allows businesses to deduct up to $1,160,000 from their taxes in the purchase year for specific business-related tangible personal property costs.
Qualifying Section 179 Property includes:
- Off-the-shelf computer software
- Office furnishings
Thanks to the Tax Cuts and Jobs Act, businesses can also deduct costs for:
- HVAC systems
- Fire protection
- Alarm systems
- Security systems in non-residential properties
Tax Tip: To maximize your tax benefits, consider spreading out your purchases of Section 179 property across different tax years
Retirement Plan Deductions for LLCs and Corporations
Corporations and LLCs can deduct contributions they make to qualified retirement plans. Numerous plan options are available with different deduction limits. While some plans grant immediate vesting benefits, others introduce staggered vesting over time.
Contributions within these plans grow tax-free until employees receive them due to retirement, disability, or death. At that time, the distributions become subject to income tax.
Employees moving to new jobs can seamlessly transfer their vested interest to their new employer’s plan or a Rollover IRA without facing any income tax implications.
Tax Benefits for Children in LLCs and Corporations
Business owners can hire their minor children for after-school or vacation work. This arrangement offers kids a way to earn tax-free allowances or set aside money for education.
If another taxpayer claims a child as a dependent, that child can earn up to $13,850 without needing to file a tax return.
While corporations or LLCs must make Social Security contributions for employed children, these kids can file a Form W4E to exempt themselves from withholding tax. Additionally, these young earners can invest up to the current limit on an IRA or Roth IRA.
Business Entertainment and Meals Deductions for LLCs and Corporations
Corporations or LLCs can claim a 50% deduction on meal costs during business entertainment or professional development events. Additionally, meal expenses with employees are fully deductible.
Tips for Maximizing Business Entertainment and Meal Deductions:
- Document Everything: Always keep detailed receipts of your business-related meals. Note down the purpose of the meal, the attendees, and the business relationship to ensure compliance with tax regulations.
- Separate Alcohol Costs: If alcohol is part of your business meal, itemize it separately on the bill. The IRS can be stricter with alcohol-related deductions.
- Limit Lavish Spending: While there’s no set limit on how much you can spend, the IRS stipulates that your meal expenses should be “ordinary and necessary,” so avoid overly extravagant meals.
- Stay Updated on Tax Laws: Tax laws and percentages related to meal deductions can change. Make sure you’re aware of the latest tax laws or consult with a tax professional to ensure you’re claiming the right amounts.
- Employee Events: Company-wide events, such as holiday parties or annual picnics, often qualify for a 100% deduction. Make sure to track these expenses separately.
Education Expense Deductions for LLCs and Corporations
Corporations or LLCs can deduct up to $5,250 in education expenses to help their employees enhance or maintain their skills. Additionally, employees don’t need to include reimbursements from the employer’s education assistance program in their income.
Longevity and Productivity Award Deductions for LLCs and Corporations
Corporations or taxable-LLCs can deduct up to $400 for tangible property awards given to employees as recognition for longevity or productivity. Businesses can selectively grant these awards every 5 years, even to owners who work in the business. Importantly, recipients don’t need to include the award’s value in their income.
Business owners need to be aware however that certain intangible rewards are not eligible for this deduction. Ineligible rewards include:
- gift cards,
- meals, or
Subscription Deductions for LLCs and Corporations
Corporations or taxable-LLCs can deduct membership dues for business or professional organizations, as well as the costs of newspapers and subscriptions that pertain to the business. Employees benefiting from these don’t need to include these costs in their income.
Continuing Education and Convention Deductions for LLCs and Corporations
Corporations or LLCs can deduct expenses when their employees, or owner-employees, attend conventions or continuing education events. These include expenses related to:
- meals, and
- program fees.
Importantly, employees don’t need to count these reimbursements as part of their income.
Tips for Maximizing Deductions on Conventions and Continuing Education:
- Keep Detailed Records: Ensure you have a clear paper trail of all expenses. Save receipts, invoices, and registration details. Document the business purpose of each expense.
- Understand the 50% Rule: Typically, only 50% of meal expenses at these events are deductible. Even if meals are part of a convention or education program, this rule often applies.
- Domestic vs. International Travel: For international conventions, the IRS may require a clearer connection between the event’s location and your business. Always check the specific requirements if considering overseas events.
- Directly-Related Test: Make sure the convention or education directly relates to your business or trade. The more specific and relevant to your industry, the more likely it is to be deductible.
- Employee Participation: If you’re sending employees, ensure they understand the business nature of the trip. It’s a good idea for them to have a schedule and a list of objectives for the event.
- Watch the Timing: If a convention or seminar extends over a weekend or has significant non-business days, only the business-related days may be deductible.
Independent Contractor Deductions for LLCs and Corporations
Establishing a corporation or taxable-LLC offers significant tax advantages for professionals like consultants or manufacturer’s representatives. By channeling their income through these entities, they can potentially maximize their earnings and enjoy more financial flexibility. Many retired executives adopt this approach, to leverage tax benefits when offering consulting services to their former employers or other clients.
How to Set Up Contractor Agreements for Tax Benefits:
- Sign a Clear Agreement: Ensure your corporation or LLC has a formal agreement with the client or manufacturer.
- Specify the Relationship: The agreement should clarify that your entity acts as an independent contractor.
- Direct Payment: The corporation or LLC should receive payment directly, bypassing employment taxes or withholding.
- Maintain Independence: By avoiding any employment ties, you ensure the desired tax advantages and safeguard the corporation or LLC’s independent status.
Following these steps, your business can capitalize on the available tax benefits.
How Does a Corporation or LLC Choose a Fiscal Year?
Corporations and taxable-LLCs can maximize their tax benefits, By understanding and strategically choosing a fiscal year.
A C-Corporation or taxable-LLC has the flexibility to select a fiscal year that overlaps with the standard individual income tax year ending on December 31. By doing so, any income the corporation or taxable-LLC earns before December 31 can be offset by compensation paid out after December 31 but still within that entity’s fiscal year.
Here’s a breakdown of the process:
- Choose Your Fiscal Year End: Decide on any month within twelve months of your corporation or LLC formation to end its fiscal year.
- File Your Tax Return: Ensure submission of the corporation’s tax return within 2.5 months following its fiscal year-end. Use this return to make your fiscal year election.
Always remember that an S-Corporation or a standard LLC will conclude its fiscal year on December 31 each year, regardless of its formation date.
How to Make Loans From an LLC or Corporation
Business owners taking advantage of the accumulated earnings of a C-Corporation or taxable-LLC by borrowing funds from the company at a favorable interest rate
Here’s a detailed overview on structuring loans from an LLC or corporation:
- Borrow Up to $10,000 Interest-Free: Owners can access this amount per individual without any interest charges. However, loans exceeding this limit should bear a standard 6% interest.
- Extend Loans for Additional Capital: Owners can offer more capital if the business entity needs more funds than the initial investment. Notably, areas like Delaware, Florida, and Nevada do not mandate a minimum capital contribution.
- Utilize Earnings for Repayment: The beauty of this approach lies in repaying loans using earnings taxed at a favorable 21% rate, ensuring funds aren’t just sitting idle.
- Maintain IRS-Approved Debt to Equity Ratios: Avoid potential IRS pitfalls by ensuring repayments don’t cross 5 to 10 times the initial capital contributed by owners. And, always cement these transactions with Promissory Notes.
Top Tips for Operating Your LLC or Corporation
Managing an LLC or corporation comes with many intricacies. The following guide provides actionable steps to help you navigate your responsibilities.
1.) Sign Company Documents Appropriately
For every business document or contract, always use the official entity name, underlining the importance of preserving the limited liability of its owners. The recommended signature format is:
[Corporation or LLC Name]
[Your Title, e.g., President or LLC Managing Member]
2.) Secure Necessary Licenses
Ensure your LLC or corporation holds valid business licenses at the necessary city, county, and state levels. Regularly renew them to avoid potential legal issues.
3.) Understand Multi-State and International Requirements
If your Delaware, Florida, or Nevada LLC or corporation intends to operate beyond its state borders or overseas, familiarize yourself with additional qualifications. This might involve acquiring a Certificate of Good Standing or an Apostille.
4.) Check Trademark and Domain Availability
Although a name might be available in your state, it doesn’t guarantee its availability elsewhere. Conduct exhaustive searches for potential trademark or domain conflicts in your target locations.
5.) Set Up the Right Address and Banking Details
Your Delaware, Florida, or Nevada LLC does not need a state-specific address or bank account. Explore flexible options that suit your operational needs. If necessary, consult experts for guidance.
6.) Stay Compliant with Annual Meeting Mandates
Delaware, Florida, or Nevada corporations should host annual meetings for electing or re-electing officers and directors. While LLCs are exempt, staying informed and compliant remains crucial.
Taking these actions ensures a smoother operation for your entity, keeping you on the right side of regulations and maximizing your entity’s benefits.
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