Question: Is it true that I save tax dollars if I form an LLC?

Answer: Generally speaking, personal tax rates are lower than corporate tax rates. Corporate income is taxed at 34 to 39 percent. Singles making under $80,000 and marrieds making under $160,000 have a personal income tax of 25 percent. This means that businesses with incomes that are less than $350,000 may experience tax savings by forming an LLC instead of a corporation.

However, businesses with income of $350,000 and $10,000,000 may experience tax savings by forming a corporation. This is because the personal rates exceed corporate rates by 1 percent (35-LLC, 34-Corp) for businesses in this income range.

When corporations declare dividends to their owners, the dividends are not deductible to the company. However, the owner pays a low dividend rate of 15 percent or less on these earnings. In this case the tax (to the owner) is less, but the company doesn’t get to deduct the expenses before paying its corporate taxes-hence “double taxation.” Paying too much in dividends (or not enough) can open up the company to penalties by the IRS.

From an operational standpoint, an LLC is cheaper to form and operate in most states. It requires fewer formalities, like annual meeting, minutes, publication notices, etc. However, if you plan to “go public” or bring on investor/shareholders, the corporation is more flexible in this regard. 

As a compromise, business owners can form an S corporation.  This is a standard corporation that chooses to be taxed like an LLC. 

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Note: The examples provided here are for illustrative purposes. Tax laws change frequently. When personal or corporate tax rates change, the advantages/disadvantages of a given business structure also change. As a result, it is always a good idea to talk to a tax professional.