All small business owners — from entrepreneurs to startups to freelancers — have to pay taxes. When you’re starting a new business, you’re likely considering whether to open a sole proprietorship or a limited liability company (LLC). One big consideration when deciding on your business entity is sole proprietorship vs. LLC taxes.
In this article, learn how LLCs and sole proprietors are taxed, the advantages of each, and our best tips for saving money on your business taxes from Nav’s experts.
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Are LLCs and Sole Proprietorships Taxed the Same?
LLCs and sole proprietors are basically taxed the same — but it can differ. When a sole proprietorship or LLC is founded, they automatically receive what’s called pass-through tax status. This means that any taxes the business pays pass through to the owner’s personal tax return. However, although an LLC is technically an unincorporated business, it can choose to be taxed as a corporation instead.
Pass-through taxation
An owner of a sole proprietor or a single-member LLC that chooses to stick with pass-through taxes will fill out a Schedule C form with their tax return. This form reports your business income. In this scenario, any income you receive from your business will be taxed at the tax rate for your personal income tax. Anyone who is self-employed may also have to pay self-employment taxes throughout the year.
A similar scenario applies to multi-member LLCs, or LLCs that have more than one registered owner, but it’s a bit more complicated. Each owner has to include their business’s taxes on their personal tax return, along with a Schedule K-1 that outlines how much of the business income is their own. But then, the multi-member LLC has to file a business tax return with the IRS using Form 1065.
Corporate taxation
However, LLCs can choose to be taxed as a corporation — something that sole proprietors can’t do. They can choose either an S-Corporation (S-Corp), which also has pass-through taxation, or a C-Corporation (C-Corp) structure, which requires you to pay a federal (and sometimes local) corporate income tax. In some cases, it can save a business money to be taxed as a corporation, but it depends on your individual circumstances. We cover more about how to save money on taxes below.
Check out Nav’s guide for more on LLCs vs. sole proprietors.
What Are 3 Advantages of a Sole Proprietorship Taxing Schedule?
Pros
- You don’t have to pay annual filing fees.
- There’s no annual report required to maintain your legal status.
- Sole proprietor taxes are simple to file.
What Are 3 Advantages of an LLC Taxing Schedule?
Pros
- Business income is separate from your personal finances.
- Get better liability protection for your personal assets. You’ll have less personal liability risk because you’re a separate entity from your business.
- You can choose between several taxation methods.
How Do LLCs Minimize Taxes?
There are many ways to minimize the amount you pay when you file taxes, largely depending on the business entity and type of taxation you choose. And there are advantages to each — which one is right for you depends on your situation. For example, if you’re an LLC owner that operates as a pass-through entity (or a sole proprietor), you may be able to qualify for a 20% discount on your taxes under the most recent tax law.
On the other hand, you can avoid paying self-employment taxes by operating as an S-Corp. Meanwhile, if you become a C-Corp, you will have to pay corporate tax but your business dividends get taxed at a lower rate than regular business income.
Again, when it comes to your business finances and making sure your business profits are working well for you, check in with a tax professional to increase your legal protection.
What Can I Write Off as an LLC?
The expenses from your business bank account that you may be able to write off are the same whether you’re a sole proprietor or an LLC. If you spend money solely to help run your business and it’s considered “ordinary and necessary,” you may be able to deduct the cost.
The most common business expenses you can write off include:
- Office equipment
- Home office expenses, like rent and utilities
- Travel expenses
- Software subscriptions
- Mileage
- Health insurance
- Capital expenses
- Cost of goods sold
Keep in mind that the items that are deductible depend on your specific circumstances, and it’s a good idea to use a tax professional when filing your income tax returns.
How Do LLCs Maximize Tax Deductions?
No one likes to pay taxes. But tax deductions lower how much of your income is considered taxable, therefore lowering your tax bill. And having more deductions you can take is one of the advantages of running your own small business.
The best way to beef up your business tax deductions is to use top-notch accounting software and work with a reliable tax professional. Using software will limit the number of errors you make in your bookkeeping and will make it easier to send your books to your accountant. A tax professional knows local, state, and federal tax laws and understands how to amplify your deductions in ways that you would have likely never thought of on your own.
Nav’s Tips for Forming an LLC
When you’re choosing the type of business you want to establish and you land on an LLC as your chosen legal entity, check out our roundup of the 15 steps to establishing a business. We’ll walk you through the processes for things like:
- Choosing your business name or doing business as (DBA) name
- Getting a business bank account
- Finding the right business credit cards
- Learning how to establish business credit
- Writing your LLC operating agreement
When you’re forming an LLC, you’ll have to file your articles of organization with the secretary of state in your state of residence or the state where you want to register your business. When you file articles, you’ll have to have a registered agent. In many states, you can act as your own registered agent. Also, look into any possible business licenses and permits you might need. And be sure to get an Employer Identification Number (EIN) for free online so you can avoid using your Social Security number on public forms.
Consider Nav your partner in all things small business. If you’re ready to apply for financing, head to Nav to see the best small business loans you’re most likely to qualify for based on your unique business data.
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Tiffany Verbeck
Digital Marketing Copywriter, Nav
Tiffany Verbeck is a Digital Marketing Copywriter for Nav. She uses the skills she learned from her master’s degree in writing to provide guidance to small businesses trying to navigate the ins-and-outs of financing. Previously, she ran a writing business for three years, and her work has appeared on sites like Business Insider, VaroWorth, and Mission Lane.