Business structure
The tax benefits of an LLC
An LLC’s main benefit is legal: it separates your personal assets from the business’s debts. Its tax benefit is flexibility. By default an LLC is taxed exactly like a sole proprietorship or partnership, so forming one does not lower your taxes on its own; what it gives you is the option to be taxed as an S corporation or C corporation when that would save money.
Pass-through taxation
By default an LLC pays no federal income tax itself. A single-member LLC is a disregarded entity reported on the owner’s Form 1040; an LLC with two or more members is a partnership that files Form 1065, due March 15 for a calendar year, and passes each member’s share of profit or loss through on a Schedule K-1. The profit is taxed once, on the owners’ returns, instead of at the company and again when paid out, as with a C corporation.
The S corporation election
An LLC can elect to be taxed as an S corporation on Form 2553, filed no more than 2 months and 15 days after the start of the tax year it should take effect, or at any time in the year before. It then pays you a reasonable salary through payroll, and profit above that salary comes out as distributions that are not subject to self-employment tax. For owners with steady profit well above a fair salary, this is where an LLC’s tax savings usually come from.
The trade-off is cost and work: payroll, a separate Form 1120-S, and the IRS rule that you must be paid reasonable compensation before taking distributions.
Other tax features
Beyond the S corp election:
- Qualified business income deduction: owners of pass-through businesses, including LLCs, can deduct up to 20% of qualified business income. Wages an S corporation pays you do not count as qualified business income.
- C corporation option: an LLC can elect on Form 8832 to be taxed as a corporation at the flat 21% federal rate, which can suit a business that keeps its profit to reinvest.
- Flexible profit splits: a multi-member LLC taxed as a partnership can allocate profit among members as its operating agreement provides, within the tax rules.
What an LLC does not change
A single-member LLC that does not elect S status pays the same income tax and the same 15.3% self-employment tax as a sole proprietor, on the same Schedule C. Your deductions are the same too: business expenses, a home office or car use are deductible because you are in business, not because you have an LLC.
The Illinois costs
An Illinois LLC has state costs a sole proprietorship does not:
| Cost | Amount |
|---|---|
| Articles of organization | $150 |
| Annual report | $75 a year |
| Personal property replacement tax | 1.5% of net income for multi-member LLCs and LLCs taxed as S corporations; none for a single-member LLC |
Thinking about an LLC or an S election?
We form LLCs in all 50 states, starting at $250 plus the state fee, file Form 2553 when the numbers support it, and run the yearly returns. In Illinois we can also be your registered agent and file your annual report for $150 a year.
Questions people ask
Does an LLC save on taxes?
Not by default. A default LLC is taxed like a sole proprietorship or partnership. The savings come from electing S corporation status, which can cut self-employment tax once profit comfortably exceeds a reasonable salary.
What is the biggest tax benefit of an LLC?
Flexibility: it is pass-through by default, with no entity-level federal income tax, and it can elect S corporation or C corporation treatment later without changing the legal company.
Do LLC owners get the QBI deduction?
Generally yes, as owners of a pass-through business: up to 20% of qualified business income, subject to the income limits. An S corporation owner’s salary does not count.
Is an LLC or a sole proprietorship better for taxes?
They are taxed the same unless the LLC elects S status. An LLC costs more in Illinois ($150 to form, $75 a year) but adds liability protection and the option to elect.
Where these rules come from
- IRS: Limited liability company (LLC)
- IRS: Instructions for Form 2553
- IRS: Partnerships
- IRS: Qualified business income deduction
- IRS: S corporation compensation and medical insurance issues
- Illinois Limited Liability Company Act, 805 ILCS 180/50-10 (fees)
- Illinois Department of Revenue: tax rates
General information, current when written, not advice about your situation. Fees and forms change; the official pages above are the authority.
