How To Avoid Double Taxation With An LLC

There are two primary reasons to form a business entity. The first is to limit your personal liability for business debts. If you operate your business as a sole proprietorship or as a partnership then debts of the business (including lawsuits) are your debts personally. This means that a business creditor--including someone with a judgment against your business--can come after your personal assets such as your home, car, and personal savings.

A traditional corporation solves the problem of limited liability, though there are reasons why an LLC can be better protection against personal liability than a corporation.

A corporation has the problem of double taxation.

With an LLC you can avoid double taxation. When a corporation earns a profit, it is taxed at a special corporate rate which is similar (but not identical) to personal income tax rates. For the owners of a corporation to spend their profits, they must take the profits as dividends. The owner is taxed a second time on recieving the dividend. Hence, double taxation.

An LLC can completely avoid this double taxation by choosing to organize as a pass-through entity. Thus, an owner of an LLC only pays tax once, at their personal income tax rate. The IRS and state law has made choosing pass-through taxation relatively easy (by the IRS's standards). You simply check a box on your Articles of Organization form for your state.

Find out more out forming an LLC in your state.