The landscape of work has drastically changed over the last decade. More and more businesses are offering remote or hybrid types of work, and everyone seems to be looking for more flexibility in their schedule. This has led to new trends in the workforce. Side hustles, fractional roles, and contract roles are all becoming increasingly popular as people look to strike the right balance in their lives between work and personal time. But as more people use these types of work to their advantage, it’s also important to make sure that you know how to keep as much of your income as possible. That’s where an LLC and all its great tax advantages can come into play.
What is an LLC and How does it Impact the New Wave of Entrepreneurs?
So, what exactly does it mean to have an LLC? A limited liability company, or LLC for short, is a legal entity in the United States that can be used to own, operate, and protect a business. They work somewhat like corporations, but are generally simpler to operate under, which makes them great for gig workers or small business owners.
A new wave of entrepreneurs has resulted from the rise of “new age work” as side gigs and contract work become more and more common. More than half of Americans say they have some sort of side hustle to help generate more income out of their full-time job, and this isn’t the only area where we can see this trend. Fractional roles have been on a steady rise, and have seen an increase of 57% since 2020 in the United States. Contract gigs have seen similar trends as well.
For anyone who has their own business, a side hustle, fractional role, or does contract work, it can be beneficial for you to operate under an LLC for tax purposes since LLCs give you more flexibility. Let’s look at some of the reasons why this is the case.
Tax Advantages of an LLC
Tax Flexibility
Arguably the biggest benefit of setting up an LLC is that you as the owner can choose how you will want to be taxed. When you create an LLC, you can choose to be taxed as a sole proprietor, a partnership, an S-Corporation, or a C-Corporation. Being able to choose between these options allows you to choose the most beneficial approach for your unique work situation when it comes to filing your taxes.
Avoiding Double Taxation
Another massive benefit of having an LLC is that it offers pass-through taxation. What this means is that the owner can claim anything the company earns on their personal income statement, which helps avoid double taxation. LLCs do generally tend to have more flexibility when it comes to taxes when compared to corporations, as the owners of an LLC can choose between pass-through taxation methods for their company or corporation taxation. If you choose to be taxed as a sole proprietor or a partnership, you avoid the double taxation that you would incur if you were being taxed as a corporation.
Various Business Deductions
Since an LLC is a type of business, you can write off various expenses as business tax deductions to help lower your income tax. There are a lot of common deductibles you can consider as a business expense, such as any advertising you do, any office expenses, health care insurance, startup costs, internet expenses, and the list goes on. To see a full list of common deductions, click here.
It is important to remember that when it comes to tax deductions, you must keep all documentation of the expenses, including receipts to prove that your deduction is legitimate. You want to avoid incorrect filings, as this can lead to audits and fines by the government.
It’s also important to keep in mind that some deductions do have set limits. For example, the limit on deductions for any start up costs of a business is currently set at $5,000 and another $5,000 for organizational expenses. Other than that, as long as the expense falls into a qualified business expense and you have the documentation to support it, you can claim it. If you’re ever unsure of any limits on your deductions, make sure to work with a financial planner or tax specialist who can guide you through the process.
QBI Deductions
Another benefit to having an LLC set up for your business is what’s known as QBI deductions. Qualified Business Income, or QBI, is a type of deduction that is a bit newer for LLCs. If your business qualifies for a QBI deduction, your business can claim up to 20% of the QBI as a tax deduction for that year. (Though this may be going away after 2025.)
There are certain requirements you must meet to make sure you can claim this deduction, such as making a certain amount of money in your business. For 2024, single filers must make less than $191,950, and joint filers must make less than $383,900. There are some other criteria that you must meet as well, so make sure to review the full list of criteria with a financial specialist.
Here's an example of how QBI could work in your favor. Let’s say that your tax filing status is single, and your QBI income for a year is $190,000, which is below the income limit to use the QBI deduction. With the QBI deduction, 20% of your $190,000 is taken off your income, so in this case $38,000 is reduced, leaving your adjusted taxable income at $152,000. If you have another $40,000 in qualified business expenses, you can lower your taxable income further down to $112,000. At $112,000, you have an effective federal tax rate at about 18.55%, which results in a tax liability of $20,776.
Compare this to your take home income without an LLC. In this scenario, your taxable income is $190,000 at an effective federal tax rate of 20.86%, leaving you with a tax liability of $39,634. By utilizing the QBI deduction and having additional business deductions, you save a whopping $18,858 that you can allocate to wealth-building investments.
Other Benefits of an LLC
Outside of the tax benefits and general flexibility you can get by using an LLC, there are other benefits that you can use to your advantage and should know about. LLCs do offer a form of liability protection, meaning that LLC owners aren’t personally liable for business debts or other obligations. This means that if your business goes under, your personal assets are safe. LLCs also offer a form of brand protection as you build your business up and can build more credibility and trust with customers as you look for new work and ways to keep your business going.
Creating an LLC is a simple and easy process as well, and you can have multiple LLCs at one time. This can be great if you own and operate multiple businesses, as it can keep each business’s assets and liabilities separate from one another. If something happens to one business, your other businesses are not at risk, which can give you peace of mind as the owner.
TLDR Summary
If you own a business, a side hustle, fractional role, or do contract work, consider setting up a limited liability company, or LLC, if you haven’t already.
Tax flexibility allows you to choose to be taxed as a sole proprietor, a partnership, an S-Corporation, or a C-Corporation, with tax advantages for each option.
If you choose to be taxed as a sole proprietor or a partnership, you avoid the double taxation that you would incur if you were being taxed as a corporation.
You can write off various qualified expenses as business tax deductions to help lower your income tax.
If your business qualifies for a QBI deduction, your business can claim up to 20% of your Qualified Business Income as a tax deduction for that year. (Though this tax privilege may expire after 2025.)
LLCs also provide liability protection and are simple and easy to set up.
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