Forming a Limited Liability Company (LLC) is one of the most popular ways for entrepreneurs and small business owners to structure their operations in the U.S. LLCs offer flexibility, liability protection, and tax advantages, but only if you understand the tax laws that apply. Beyond setup basics, a clear grasp of federal and state tax laws can save you from surprises and set your company on a solid path.
Here are seven key tax laws every business owner should know before forming an LLC.
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1. LLCs Are “Pass-Through” Entities by Default
By default, the IRS treats LLCs as “pass-through” entities. This means the company itself doesn’t pay federal income taxes; instead, profits and losses flow through to the individual members’ tax returns.
This structure avoids double taxation, which corporations often face. However, members must remember that pass-through income is still subject to individual tax rates, which can vary depending on your total personal income.
If you’re just beginning the setup process, it’s wise to visit the website, Boostsuite, for guidance on structuring and naming your LLC, ensuring compliance from the start.
2. Self-Employment Taxes Apply
LLC owners who actively work in the business are typically considered self-employed. This makes them responsible for self-employment taxes, which cover Social Security and Medicare.
As of 2024, the self-employment tax rate is 15.3% on net earnings up to $160,200, with a reduced rate applying above that threshold. Business owners need to budget for this additional expense, as it is separate from regular income tax.
3. You Can Elect Corporate Taxation
One of the biggest advantages of an LLC is flexibility in taxation. LLCs can choose to be taxed as:
- An S corporation, allowing owners to pay themselves a reasonable salary and potentially reduce self-employment taxes.
- A C corporation, which subjects profits to corporate income tax but may offer benefits if profits are reinvested in the business.
This election is made by filing IRS Form 8832 or Form 2553. Deciding on corporate taxation can reduce overall tax liability but requires careful planning and compliance.
4. State Taxes Vary Widely
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While federal tax rules are consistent, state tax obligations differ significantly. Some states impose franchise taxes or annual fees on LLCs, regardless of profits. Others may have higher income tax rates that flow through to members.
For example:
- Texas charges a franchise tax on most LLCs once revenue exceeds a set threshold.
- California requires an $800 minimum annual franchise tax, even if the business has no income.
Before forming your LLC, investigate your state’s rules so you’re not blindsided by annual fees or filing requirements.
5. Deductible Business Expenses
LLCs can deduct ordinary and necessary business expenses, reducing taxable income. This includes costs like rent, salaries, equipment, utilities, and insurance.
However, it’s essential to maintain clear records and separate personal and business accounts. Mixing finances can create IRS scrutiny and weaken liability protections. According to the IRS Small Business and Self-Employed Tax Center, maintaining proper records is one of the top practices for avoiding compliance issues.
6. Employment Taxes if You Hire Workers
If your LLC hires employees, you’re responsible for withholding and paying employment taxes. These include:
- Federal income tax withholding.
- Social Security and Medicare taxes (the employer portion).
- Federal and state unemployment taxes.
Failing to withhold or deposit payroll taxes can lead to severe penalties, so many small businesses choose to use payroll service providers to manage compliance.
7. Estimated Taxes Are Required
LLC owners generally must pay estimated taxes quarterly, since taxes aren’t withheld automatically. The IRS requires individuals who expect to owe more than $1,000 in tax for the year to make estimated payments.
Deadlines typically fall in April, June, September, and January of the following year. Missing these deadlines can trigger penalties and interest, so owners should plan ahead and use IRS Form 1040-ES to calculate payments.
Forming an LLC is about more than just protecting your personal assets, it’s about choosing a structure that works for your financial future. By understanding these seven tax laws, you can make informed decisions about how your LLC will be taxed, what expenses you can deduct, and how to stay compliant at both state and federal levels.
Because rules vary and your business circumstances are unique, consult a tax professional or attorney before finalizing your LLC. With the right planning, you’ll not only avoid costly mistakes but also maximize the tax advantages an LLC provides.
