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Tax Benefits of an LLC
Tax Benefits of an LLC – pass through taxation
In a most forms of corporations, such the common C Corporations, the corporation is an independent entity that will be taxed on its earnings. One of the tax benefits of an LLC is that profits, losses, deductions and credits will be passed through to the members (owners) and the company will not pay any tax. The tax is instead paid by each member and this system prevents double-taxation. LLC’s are taxed as partnerships by the state as well as on a federal level and the members (owners) will only pay one level of tax.
The tax benefits of an LLC is similar to those of an S Corporation, but before you decide to form an S Corporation you should be aware that such an entity is more similar to a C Corporation in most regards, including the amount of necessary documentation and the need to form a board of directors. Another notable restriction that sets the S Corporation aside from both LLC’s and C Corporations is that an S Corporation can have no more than 100 shareholders. There is no maximal amount of shareholders / members for C Corporations and LLC’s.
The LLC entity was created to be flexible and one of its perks is that if you decide that it would be better to have your LLC taxed as a separate entity, you simply file IRS Form 8832. The LLC will then be taxed instead of its members.
Tax Benefits of an LLC – no requirements of proportionality
For most business entities, including the C Corporation, profits and losses must be proportional to ownership interests unless you are willing to accept severe tax ramifications. One of the tax benefits of an LLC is that disproportional allocations of profits and losses do not have to lead to this type of tax repercussions. The general rule is that the LLC is free to decide how to spread tax allocations and cash distributions among its members.
Tax Benefits of an LLC – inclusion of company debt
One of the most interesting, but not very famous, tax benefits of an LLC is that its members may include company debts in the tax basis of their ownership interests. If you have a business that generates tax losses, the difference between forming an LLC and forming an S Corporation can be massive. For an S Corporation shareholder, the limitations regarding inclusion of corporation debts are certainly considerable.
Tax Benefits of an LLC – step up the tax basis
Last but not least, one of the tax benefits of an LLC is that the LLC may step up the tax basis of its assets when a transfer of ownership of an LLC interest is carried out. The tax bases of its assets may be stepped up to a fair market value and this will naturally make the depreciable basis larger, which in turn will have a large impact on taxation. This mechanism makes it possible decrease the taxable income without impacting cash flow. |
