Forming an LLC? Here’s What It Actually Does for Your Taxes
The LLC Illusion: What Small Business Owners Need to Know About Taxes, Liability, and the IRS
It happens all the time. A small business owner proudly says, “I'm an LLC now.” The expectation? Lower taxes, more write-offs, less liability. The reality? In most cases: nothing changes.
There’s a growing myth being sold online and by some professionals that forming an LLC is a tax strategy. It’s not. An LLC is a legal entity created at the state level not a federal tax classification. Unless you elect otherwise, the IRS ignores your LLC for tax purposes. Literally.
The Tax Reality: LLC = Disregarded Entity (Most of the Time)
If you're a single-member LLC (SMLLC), the IRS treats you as a disregarded entity by default. That means you file your taxes exactly the same as a sole proprietor, using Schedule C of Form 1040. See IRS Publication 3402 – Taxation of Limited Liability Companies (LLCs).
“A limited liability company (LLC) is an entity created by state statute. For federal tax purposes, an LLC may be treated as a sole proprietorship, a partnership, or a corporation. A single-member LLC is disregarded as an entity separate from its owner, unless it elects to be treated as a corporation.”
So if you're a solo business owner and you form an LLC but don’t elect S corporation or C corporation status via Form 8832 or Form 2553, you’re still filing a Schedule C just like before.
The Oversell Problem: "Start an LLC and Save on Taxes!"
There’s a whole cottage industry of marketers, influencers, and even some advisors who oversell LLCs as a magic bullet for taxes. But forming an LLC does not reduce your tax liability. You still owe:
Self-employment tax (15.3%) on your net earnings
Income tax based on your total taxable income
Estimated quarterly payments (Form 1040-ES)
The IRS makes no distinction between you and your disregarded LLC when it comes to income reporting and liability for taxes. See [IRC § 7701(a)(2), § 7701(a)(3), § 7701(a)(30)]. These sections define entities and tax classifications, including disregarded entities.
The LLC does not change your audit risk, your allowable deductions, or your self-employment tax. If you want those things to change, you need a different structure like an S corporation, and even then, only if it’s appropriate.
The Liability Trap: LLC ≠ Automatic Protection
LLCs were designed primarily for legal liability protection, not tax savings. And even that protection is limited if the LLC formalities are not respected.
A few examples of what can weaken or eliminate your liability shield:
Commingling personal and business funds
Not maintaining a separate business bank account
Failing to sign contracts in the name of the LLC
Not documenting decisions or operations
Using the LLC to commit fraud or negligence
This is where the legal concept of "piercing the corporate veil" comes in. Courts can disregard your LLC status if it looks like you and the LLC are essentially one and the same. See United States v. Mazzeo, 306 F. Supp. 2d 294 (S.D.N.Y. 2004)
“Where there is such unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist… the corporate veil may be pierced.”
So while an LLC may offer some protection, it’s not a “get out of jail free card.” Especially for single member LLCs, where the owner and entity are often financially indistinguishable, courts and creditors may not honor the legal separation.
So Why Form an LLC at All?
To be clear: forming an LLC can be a smart move for the right reasons. These include:
Creating a separate legal identity for the business
Limiting liability in multi member or high risk ventures
Preparing for future tax elections (e.g., electing S-corp status later)
Enhancing professional appearance for clients or vendors
But if you're forming an LLC thinking it will:
Cut your taxes
Avoid self-employment tax
Eliminate personal liability
Protect your personal assets without any formalities
…then you may be in for a surprise.
Final Thoughts: Be Realistic About What an LLC Can and Can’t Do
LLCs are overused and oversold. The structure can be helpful, but it is not a tax strategy on its own. For most small business owners, especially single member LLCs, you’re still a Schedule C filer, and your tax obligations remain the same. Without clean recordkeeping, formalities, and strategic planning, the LLC won’t offer much legal protection either.
Think of an LLC as a tool, not a solution. If you're serious about saving on taxes or protecting yourself legally, it takes more than paperwork it takes informed action, compliance, and sometimes, a more advanced structure.