At least once every month or so, a client or prospect comes to us after having formed an LLC. They are proud and ready to get all those tax savings that they heard about from friends or social media that they will get. They have visions of writing off their household expenses or automobile purchases. After all, they are now a business owner, and that means the “write-offs” will follow.
Usually, my first question is, “Why didn’t you call us first?” and there is usually some shrugging, or they saw on TikTok how easy it would be. If you take away nothing from this article, let it be that you should ALWAYS talk to your tax professional before making major decisions, including forming a business entity.
Now back to the part where I burst their bubble. An LLC (limited liability company) is, by default, a disregarded entity for federal tax purposes if it has a single owner or member. That means it is not recognized as an entity like a corporation is by the Internal Revenue Services. LLCs are recognized at the state level. But wait, you say – lots of people have LLCs. Indeed, they do; oftentimes, someone will form an LLC for liability protection, so you should always consult a competent attorney to form your entity. You should not do it yourself.
An LLC is versatile in the fact that you can elect to have your LLC treated as a C corporation or S corporation, or if you have more than one member, then a partnership. If your LLC has one owner only, then it defaults to a disregarded entity, in which case you will file a Schedule C just like a sole proprietorship. The same schedule c you likely filed before if you were self-employed.
Now, sometimes it can make sense to elect to be treated as a C corporation or an S corporation. For that determination, you should consult with a tax professional. Many times people will elect s corporation status because they were told it was a good idea to save money on taxes when in fact, this was a huge mistake. Not only have you increased your costs for yearly compliance, but you have also added responsibilities such as paying yourself a salary and a reasonable salary at that. With that being said, there are a multitude of tax benefits that an S corporation or C corporation can take advantage of IF and only IF it makes sense based on your circumstances.
Now to burst another bubble – None of these benefits include “writing off” (deducting) your groceries, mortgage payment, personal vehicle expenses, or that trip to Europe. If you deduct these items, you will likely find yourself in trouble with the IRS. Telling the auditor that “Well, TikTok said this was legit” will not work, and you will be subject to penalties, interest, and possibly criminal penalties.
It is much cheaper, in the long run, to get competent advice before you make a major life decision, and as always, “If it sounds too good to be true, it likely is.”