6 Ways Your LLC Can Reduce Your Taxes (Plus Examples)

Many small business owners start LLCs every year, but very few take advantage of their available tax savings. With a little planning, tax savings can mean $1,000's in your bank account every year.

As an LLC owner, you can reduce taxes by:

1. Becoming an S Corporation.
2. Deducting business expenses.
3. Deducting retirement account contributions.
4. Deducting health insurance premiums.
5. Strategically depreciate assets
6. Offset income with prior LLC losses.

Each of these strategies can serve a crucial role in reducing your taxes by applying them to your unique situation. Let's discuss how each one works and how you can start taking advantage of it.

#1 Becoming an S Corporation

The ability to change your tax classification is the biggest driver of tax savings for many LLCs.

How is an LLC Taxed?

By default, LLCs are pass-through entities, where profits pass through to owners' individual taxes. However, LLCs can change their tax classification, changing the rules by which they are taxed.

LLCs can change their default tax classification (disregarded) to a more tax-efficient type, such as an S Corporation.

While S Corps are a pass-through entity, like a regular LLC, it allows some owners to avoid expensive self-employment taxes. Important to note that S Corps may not work for all LLCs, especially if you need more flexible ownership rules. However, if your curiosity is peaked, please checkout our S Corp tax calculator to see if changing your tax classification could savings for you.

To illustrate this, let's consider a sole proprietorship earning $100,000 annually and paying $15,300 in self-employment taxes (Social Security and Medicare). Now consider if that same owner had an LLC / S Corp also earning $100,000. They could take a $50,000 salary and a $50,000 profit distribution, reducing their self-employment tax to $8,310 – a savings of $6,990!

#2 Deducting Business Expenses

It is a common oversight among entrepreneurs that a large number of business expenses are fully tax deductible. These above-the-line deductions have a big impact on reducing your taxable income. These are some deductible expenses to be aware of.

• Phone & internet - percentage used for business.
• Business use of your car - usually based on mileage for business use.
• Educational expenses - such as books and courses to better run your business.
• Home office - area must be exclusive for business use.
• Interest on business debt.
• Advertising and Marketing.
• Professional Services: Fees paid to professionals such as accountants, attorneys, etc.

There are many more deductions LLC owners can explore. Remember that if an expense is used to grow or run your LLC, there's a good chance it's deductible. Never forget to keep complete records of all your business deductions.

Honorable Mention

The QBI or "qualified business income" deduction allows owners of eligible pass-through entities, like LLCs, to deduct up to 20% of their eligible business income on their taxes. QBI is a below-the-line deduction, which means it is mostly useful for reducing your income taxes.

#3 Deducting Retirement Account Contributions

Self-employed people can invest through a number of tax-saving vehicles, including SEP-IRA, Simple IRA, and Solo 401(k). Yes, I know that's a lot of acronyms! So, if you're new to retirement accounts, just know that while they each have pros and cons, however, they all have the same goal: to help you reduce and defer your taxes.

Here are some key tax advantages LLC owners have with their retirement accounts:

• More investment options than employees (ie, rental properties).
• More control over how you invest than employees.
• Contributions to the accounts mentioned above are deductible below the line, reducing income taxes.

The money you invest through your LLC's retirement account counts as your compensation and is contributed pre-tax. While employees have a similar option through their 401 (k) plans, the self-employed have more flexible vehicles available to them, like the SEP-IRA.

What this boils down to is you are in the driver's seat of your retirement plan to a greater degree than employees are. Because this comes with added complexity, it's important to review these options in detail with your CPA.

#4 Deducting Health Insurance Premiums

Self-employed people can deduct health insurance premiums above the line (the most valuable kind of deduction). This includes both medical and dental premiums for themselves and their dependents.

There are, of course, some restrictions to be aware of in order to claim this deduction.

1. You must report a profit from your business.
2. You must not be eligible for a plan through your spouse's employer.
3. You must manage and document premium reimbursement through your business.

Read all the details of deducting health insurance premiums in Form 7206, Self-Employed Health Insurance Deduction. You'll find a worksheet for determining your exact health insurance deduction.

#5 Strategically Depreciate Assets

Depreciation can be a useful accounting tool for allocating the losses of less profitable years to more profitable ones.

Depreciation

The practice of spreading the cost of an asset over its useful life. There are many different methods of depreciation used for both accounting and tax purposes including: straight-line and double-declining.

Using depreciation to reduce taxes may be easier for some businesses than others. However, businesses that must purchase many fixed assets in the first year of operation can use depreciation more effectively.

Take, for example, a restaurant that must purchase a lot of new kitchen equipment. Usually, a restaurant's first year of operation is not very profitable, so owners will not have much tax liability. However, in later, more profitable years, the restaurant can realize the depreciating value of its equipment to reduce its profitability on paper, saving on taxes.

Depreciation is a complex subject that takes careful planning with a tax professional. Be sure to discuss this with your CPA early on in your business.

#6 Offset Income With Losses

One overlooked advantage of LLCs is that Net Operating Losses from previous years can be deducted in future profitable years. These losses can also be used to reduce income from other sources in the same year.

Take, for example, an LLC with a net operating loss of $50,000 in 2023 and a net income of $100,000 in 2024. The owner could reduce this income to $50,000 by deducting their losses from the previous year. This assumes $50,000 is less than 80% of their taxable income.

There are some important limitations to be aware of:

• There's a limited amount of net operating losses you claim in a year (in 2024 $262,000 for single filers).
• You can only carry forward 80% of net operating losses to future years.
• Other exceptions apply as well.

While losing money is nothing to get excited about, it's extremely beneficial to know how you can leverage those losses as a business owner.

Bonus Tax Saving Ideas

Although not as popular as our list above, these are some additional strategies for LLC tax savings to discuss with your tax advisor.

• Choose the right accounting method - options include cash and accrual methods. This is a complex subject, but implementing it with your tax professional could help you defer taxation.
• Employ family members - provides opportunities for tax savings through deductible salary expenses and potential retirement plan contributions.
• Explore Tax Credits - governments sometimes offer special credits to promote innovation and employment. Credits such as the Research and Development (R&D) tax credit, Work Opportunity Tax Credit (WOTC), and Small Business Health Care Tax Credit can reduce tax liabilities.
• Invest in Tax-Advantaged Investments - Consider investing in tax-advantaged vehicles such as municipal bonds etc.
• Pass-through entity taxes - a workaround for the $10,000 SALT cap offered by some states. It reduces federally taxable income by allowing LLC owners to effectively pay their state-level tax obligations with their business.

Let's Recap How LLCs Reduce Taxes

We've covered 6 excellent ways to use your LLC to save on taxes. Each strategy — S Corps, business tax deductions, retirement accounts, depreciation, and offsetting income with past losses, have pros and cons.

However, the common thread is to start planning with your tax professional now. Each method gets harder to use the longer you wait to adopt it. So choose one that looks interesting and determine how much you could save, the effort level to claim the savings, and if it applies to your situation.

Once you've selected your favorites, bring them to your business tax advisor so you can start implementing them as soon as possible.