How to Save Money on Taxes with an LLC vs 1099 

Are you a freelancer or a small business owner looking for ways to reduce your tax liability? If so, you might be wondering whether you should operate as an LLC or a 1099 contractor. In this blog post, we will compare the tax benefits of LLC vs 1099 and give you some tips on how to choose the best option for your situation. 

What is an LLC and what is a 1099? 

An LLC, or a limited liability company, is a legal entity that separates your personal and business assets. This means that if your business gets sued or goes bankrupt, your personal assets (such as your house, car, or savings) are protected from creditors. An LLC can have one or more owners, called members, who share the profits and losses of the business. 

A 1099, on the other hand, is not a legal entity, but a tax form that you receive from your clients or customers if you earn more than $600 in a year from them. A 1099 contractor is a self-employed individual who provides services to others without being an employee. As a 1099 contractor, you are responsible for paying your own taxes, such as income tax and self-employment tax. 

How are LLCs and 1099 contractors taxed differently? 

The main difference between LLCs and 1099 contractors is how they are taxed by the IRS. LLCs can choose to be taxed as a sole proprietorship, a partnership, a corporation, or an S corporation, depending on their number of members and their preferences. Each of these tax classifications has its own advantages and disadvantages, which we will discuss later. 

1099 contractors, however, are always taxed as sole proprietors, unless they form an LLC or a corporation. This means that they have to report their income and expenses on Schedule C of Form 1040 and pay both income tax and self-employment tax (which covers Social Security and Medicare) on their net profit. The self-employment tax rate is 15.3% of the net profit, which can be a significant amount for some freelancers. 

What are the tax benefits of LLC vs 1099? 

Depending on your situation, you might be able to save money on taxes by choosing to operate as an LLC or a 1099 contractor. Here are some of the tax benefits of each option: 

Tax benefits of LLC 

• Limited liability protection: As we mentioned earlier, an LLC protects your personal assets from business liabilities, which can save you from losing your money or property in case of a lawsuit or bankruptcy. 
• Flexibility in tax classification: An LLC can choose to be taxed as a sole proprietorship, a partnership, a corporation, or an S corporation, depending on what works best for their business. For example, if you are a single-member LLC, you can choose to be taxed as a sole proprietorship, which is the simplest and most common choice. This means that you will report your income and expenses on Schedule C and pay income tax and self-employment tax on your net profit, just like a 1099 contractor. However, you can also choose to be taxed as a corporation or an S corporation, which can offer some tax advantages, such as lower self-employment tax, lower corporate tax rate, or tax deferral. We will explain these options in more detail later. 
• Deductible business expenses: As an LLC, you can deduct your ordinary and necessary business expenses from your income, which can lower your taxable income and your tax bill. Some of the common business expenses that you can deduct include: 

• Advertising and marketing costs 
• Business travel and meals 
• Office supplies and equipment 
• Rent and utilities 
• Insurance and legal fees 
• Education and training costs 
• Retirement plan contributions 
• Health insurance premiums 

• Pass-through taxation: If you choose to be taxed as a sole proprietorship, a partnership, or an S corporation, your LLC will be a pass-through entity, which means that the profits and losses of your business will pass through to your personal tax return. This means that you will not have to pay taxes twice on the same income, unlike a corporation, which pays corporate tax on its profits and then distributes dividends to its shareholders, who pay income tax on them. 

Tax benefits of 1099 

• Simplified tax filing: As a 1099 contractor, you do not have to deal with the complexity and paperwork of forming and maintaining an LLC, such as filing articles of organization, paying state fees, creating an operating agreement, keeping records, and filing annual reports. You only have to report your income and expenses on Schedule C and pay your taxes on Form 1040. 
• No double taxation: As a 1099 contractor, you are also a pass-through entity, which means that you only pay taxes once on your income, unlike a corporation, which pays taxes twice on its profits and dividends. 
• Deductible business expenses: As a 1099 contractor, you can also deduct your ordinary and necessary business expenses from your income, just like an LLC. However, you might have fewer expenses to deduct, since you do not have to pay for the costs of forming and maintaining an LLC. 

How to choose the best option for your situation? LLC vs 1099

As you can see, there is no clear-cut answer to whether you should operate as an LLC or a 1099 contractor, as both options have their pros and cons. The best choice for you depends on various factors, such as: 

• Your income level and tax bracket 
• Your business structure and goals 
• Your risk tolerance and liability exposure 
• Your personal preferences and needs 

To help you make an informed decision, here are some questions that you can ask yourself: 

• How much income do you expect to earn from your business? 
• How much self-employment tax are you willing to pay? 
• How much liability protection do you need for your business? 
• How much flexibility do you want in choosing your tax classification? 
• How much time and money are you willing to spend on forming and maintaining an LLC? 
• How important is it for you to have a professional and credible image for your business? 

Based on your answers, you can weigh the benefits and costs of each option and choose the one that suits you best. However, before you make a final decision, you should consult with a tax professional, such as a CPA or an enrolled agent, who can give you personalized advice and guidance on your specific situation. 

FAQs 

Here are some of the often asked questions about the tax benefits of LLC vs 1099: 

• Q: Can I be both an LLC and a 1099 contractor? 
• A: Yes, you can be both an LLC and a 1099 contractor, depending on your clients and projects. For example, you can form an LLC for your main business, and receive payments from your clients as an LLC. However, you can also work as a 1099 contractor for other clients, who will pay you as an individual and send you a 1099 form at the end of the year. In this case, you will have to report your income and expenses from both sources on your tax return and pay taxes accordingly. 
• Q: How do I form an LLC? 
• A: To form an LLC, you will have to follow the steps below: 

1. Choose a name for your LLC that is unique and complies with your state’s rules 
2. File articles of organization with your state’s secretary of state, and pay the filing fee 
3. Obtain an employer identification number (EIN) from the IRS, which is a unique number that identifies your business for tax purposes 
4. Create an operating agreement, which is a document that outlines the rules and responsibilities of your LLC and its members 
5. Open a business bank account and a credit card for your LLC, and keep your personal and business finances separate 
6. Register your LLC with your state and local tax authorities, and pay any required taxes and fees 
7. Comply with any other state and local regulations, such as obtaining licenses, permits, or insurance 

• Q: How do I file taxes as an LLC? 
• A: How you file taxes as an LLC depends on how you choose to be taxed by the IRS. Here are the four options that you have: 

1. Sole proprietorship: If you are a single-member LLC, or a multi-member LLC that elects to be taxed as a sole proprietorship, you will report your income and expenses on Schedule C and pay income tax and self-employment tax on your net profit. You will also attach Schedule SE to calculate your self-employment tax, and Schedule E to report any rental income or losses. You will file your taxes on Form 1040, along with any other relevant forms and schedules. 
2. Partnership: If you are a multi-member LLC that does not elect to be taxed as a sole proprietorship, a corporation, or an S corporation, you will be taxed as a partnership by default. In this case, you will file Form 1065, which is a return for partnerships, and report your income and expenses. You will also issue Schedule K-1 to each member, which shows their share of the profits and losses of the LLC. Each member will then report their share of the income and expenses on Schedule E and pay income tax and self-employment tax on their net profit. They will also file their taxes on Form 1040, along with any other relevant forms and schedules. 
3. Corporation: If you elect to be taxed as a corporation, you will file Form 8832, which is a form for entity classification election, and choose the C corporation option. You will then file Form 1120, which is a return for corporations, and report your income and expenses. You will pay corporate tax on your profits, at a flat rate of 21%. However, if you distribute dividends to your members, they will also pay income tax on them, resulting in double taxation. You will also issue Form 1099-DIV to each member, which shows the amount of dividends they received. 
4. S Corporation: If you elect to be taxed as an S corporation, you will file Form 2553, which is a form for election by a small business corporation, and meet certain eligibility criteria, such as having no more than 100 members, having only one class of stock, and having only US citizens or residents as members. You will then file Form 1120-S, which is a return for S corporations, and report your income and expenses. You will not pay corporate tax on your profits, but you will pass them through to your members, who will pay income tax on them. You will also issue Schedule K-1 to each member, which shows their share of the profits and losses of the LLC. The advantage of being an S corporation is that you can avoid double taxation and lower your self-employment tax, as you can pay yourself a reasonable salary and take the rest of the profits as dividends, which are not subject to self-employment tax. 

• Q: How do I file taxes as a 1099 contractor? 
• A: To file taxes as a 1099 contractor, you will have to follow the steps below: 

1. Receive Form 1099-NEC from each client or customer who paid you more than $600 in a year, which shows the amount of income you earned from them 
2. Report your income and expenses on Schedule C, and calculate your net profit or loss 
3. Pay income tax and self-employment tax on your net profit, using Schedule SE to calculate your self-employment tax 
4. File your taxes on Form 1040, along with any other relevant forms and schedules, such as Schedule E for rental income or losses, Schedule A for itemized deductions, or Schedule B for interest and dividend income 
5. Make estimated tax payments every quarter, using Form 1040-ES, to avoid penalties and interest 

• Q: What are some of the drawbacks of LLC vs 1099? 
• A: Some of the drawbacks of LLC vs 1099 are as follows: 

• Drawbacks of LLC:  

1. Higher costs and complexity: Forming and maintaining an LLC can be more expensive and complicated than being a 1099 contractor, as you have to pay state fees, file annual reports, keep records, and comply with various regulations 
2. More paperwork and filing requirements: Depending on how you choose to be taxed as an LLC, you might have to file more forms and schedules with the IRS and your state, such as Form 1065, Form 1120, Form 1120-S, Schedule K-1, or Form 8832 
3. Less flexibility in changing your tax classification: Once you elect to be taxed as a corporation or an S corporation, you cannot easily switch back to being taxed as a sole proprietorship or a partnership, unless you meet certain conditions and deadlines 

• Drawbacks of 1099:  

1. Higher self-employment tax: As a 1099 contractor, you have to pay both the employer and the employee portion of the Social Security and Medicare taxes, which adds up to 15.3% of your net profit, unless you qualify for certain deductions or exemptions 
2. No limited liability protection: As a 1099 contractor, you do not have the legal shield that an LLC provides, which means that your personal assets are vulnerable to business liabilities, such as lawsuits, debts, or claims 
3. Less professional and credible image: As a 1099 contractor, you might have a harder time attracting and retaining clients, customers, or partners, as they might perceive you as less serious, stable, or trustworthy than an LLC 

Conclusion 

As you can see, there are many factors to consider when choosing between LLC vs 1099 for your tax purposes. Both options have their benefits and drawbacks, depending on your income level, business structure, risk tolerance, and personal preferences. The best choice for you might not be the best option for someone else, so you should do your own research and consult with a tax professional before deciding. 

If you want to learn more about the tax benefits of LLC vs 1099, or need help with filing your taxes, you can contact us. We are a team of experts who can help you with all your tax needs, from planning and preparation to filing and resolution. We can also help you with forming and maintaining an LLC, if you decide to go that route. We are here to make your tax life easier and save you money. 

External Link: IRS Independent Contractor Self-Employment Tax: https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center