LLCs Bad for Taxes? The Truth for Business and Rental Owners
- February 9, 2025
- 7 min read
Confused about LLCs and taxes? You’re not alone. According to the U.S. Small Business Administration, about 69% of new businesses in 2017 were formed as LLCs​, leading many entrepreneurs to wonder how this popular structure affects their tax bills.
In this article, we’ll break down what an LLC really means for your taxes – especially for business owners and landlords – and whether an LLC could actually be “bad” for your tax situation.
We’ll cover key terms, simple examples from rental property (like Airbnb hosts), construction, and trucking businesses, evidence and analysis on federal and self-employment taxes, comparisons with other structures, pitfalls to avoid, and an FAQ addressing common questions.
But First... Key Terms
👉 LLC (Limited Liability Company)
A legal business structure offering liability protection. For taxes, an LLC is usually a pass-through entity – meaning the LLC itself doesn’t pay federal income tax; profits pass through to owners’ personal tax returns​.
(Single-member LLCs are taxed like sole proprietorships; multi-member LLCs like partnerships by default.)
👉 Pass-Through Taxation
Income “passes through” the business to the owners. Owners report the business profit on their personal returns and pay tax at individual rates. This avoids double taxation (being taxed at both corporate and personal level) that a C corporation might face​.
👉 Self-Employment Tax
A 15.3% tax for Social Security and Medicare applied to self-employed income (equivalent to payroll taxes for employees). LLC owners are considered self-employed by default, so LLC profits from an active business are subject to self-employment tax.
👉 S-Corporation (S-Corp)
Not a separate legal entity, but a tax status an LLC or corporation can elect. An S-Corp is a pass-through for income tax, but allows owners to take part of profits as distributions not subject to self-employment tax.
Owners must pay themselves a “reasonable salary” (which does incur payroll taxes), but profits beyond that salary can be taken as dividends free of Social Security/Medicare tax​.
This can reduce the total tax on business income if profits are high.
👉 Passive Income vs Active Income
Passive income (like most rental income) is generally not subject to self-employment tax, whereas active business income (e.g. a contractor’s earnings) is.
The IRS usually treats rental property income as passive (unless you provide substantial services or qualify as a real estate professional)​.
Real-World Scenarios
🏠Sara: The Rental Fee Surprise
Sara owns a duplex that nets $20,000 in rental income per year. She wonders if putting it in an LLC will save her taxes.
In reality, rental income is generally taxed the same whether or not it’s in an LLC – it’s passive income reported on Schedule E, not subject to self-employment tax. If Sara forms an LLC (with default taxation), she will still pay the same federal income tax on the $20K profit.
There’s no special tax break just for using an LLC (the LLC’s income passes through to her personal return). In fact, if Sara is in a state like California, the LLC would cost an extra $800/year in state LLC fees​, so it could actually increase her overall costs. (The main benefit of an LLC here would be legal protection, not tax.)
For short-term rentals (Airbnb-style) that provide hotel-like services, income could become “active” and subject to self-employment tax – but that’s due to the nature of the income, not the LLC itself​.
👷 John: The Contractor’s Tax Shortcut
John is a self-employed contractor netting about $100,000 in profit from his business.
If he operates as a simple sole proprietorship or single-member LLC (taxed the same way by default), he’ll pay income tax on $100K plus about 15.3% self-employment tax on that profit (roughly $15,300)​.
If John instead elects S-Corp status for his LLC, he might pay himself, say, a $60,000 salary and take $40,000 as a distribution. He’d pay the 15.3% payroll taxes only on the $60K salary (about $9,200), and no self-employment tax on the $40K distribution​.
His income tax stays roughly similar, but his total taxes would drop by several thousand dollars because of the self-employment tax saved. In short, an LLC by itself doesn’t cut John’s tax, but an LLC taxed as an S-Corp could save him money once his profits are high enough.
🚚 Michelle: The Trucker’s Big Savings
Michelle runs a small trucking business and earned $200,000 in profit this year.
As a single-member LLC taxed by default, she’d pay federal income tax on $200K plus self-employment tax (~$200K × 15.3%, minus the Social Security cap) – roughly $60,000+ in combined taxes. Many owner-operator truckers in this situation choose to have their LLC taxed as an S-Corp.
For example, one accountant noted that clients making over $200K net who switched to S-Corp with a modest salary (e.g. $35K) saved “almost $30K a year in taxes”​ by avoiding most self-employment tax.
While that’s an extreme case, Michelle could potentially save tens of thousands in taxes by not paying 15.3% on a large portion of her income. The trade-off is the cost and compliance of running payroll and filing an S-Corp tax return. Below, we’ll see more evidence and compare scenarios.
Find Real Savings Beyond LLC Myths
1. Why an LLC Doesn’t Guarantee Tax Savings
An LLC offers legal protection. It doesn’t lower federal taxes by default. The IRS treats a single-member LLC like a sole proprietorship. You still pay tax on all profits at your personal rate.
Some people say, “An LLC is about liability, not taxes.” That’s partly true. Forming an LLC alone doesn’t cut your federal tax bill. You must take extra steps, like choosing S-Corp or partnership status, to save.
2. Federal Income Tax: Where Most of Your Money Goes
When you earn profits through an LLC, the income passes to your personal return. Your total taxable income sets your tax bracket.
If you make $100,000, you might pay around $15,000 in federal income taxes after the standard deduction.
The 20% Qualified Business Income (QBI) deduction lowers your taxable income, but it applies to many pass-through businesses, not just LLCs.
3. The Self-Employment Tax Hit
LLC owners with active businesses pay a 15.3% self-employment tax on net profit. This covers Social Security and Medicare. It adds up fast.
If you net $100,000, you pay around $15,300 on top of regular income tax.
You do deduct half of this tax on your 1040. Yet you still feel the pain of writing checks for the other half.
4. S-Corp: The Strategy That Changes Everything
Here’s the secret weapon. Your LLC can elect S-Corp status.
Then you become both owner and employee. You pay yourself a reasonable salary, which faces payroll taxes. The remaining profits flow to you as distributions that skip self-employment tax.
This works well if you earn enough. You dodge that 15.3% on part of your income. That can save thousands each year.
5. When the S-Corp Option Makes Sense
The S-Corp approach adds some costs. You must run payroll, file a separate tax return, and meet extra rules. Many advisors say you need at least $50,000 in net profit before the savings beat the extra fees.
At higher profit levels, the numbers can really work in your favor. If you only earn $20,000, it’s usually not worth it.
6. Rental Properties: Different Rules, Fewer Perks
Rental profits often don’t face self-employment tax. So there’s no big gain from an LLC. Many investors form rental LLCs for legal protection, not lower taxes.
S-Corp status for rentals can cause problems with passive income rules. Most tax pros don’t recommend it unless you run a more active hospitality business (like Airbnb with daily services).
7. See the Numbers: Compare LLC vs. S-Corp
Imagine you earn $100,000 in profit. As a regular LLC, you pay income tax plus 15.3% on all of it. Elect S-Corp status, pay yourself a $50,000 salary, and you pay that 15.3% on $50,000 only.
The rest is a distribution with no self-employment tax. That alone can save $6,000 or more in one year.
The higher your profit, the more you can potentially save. Keep your salary reasonable, or the IRS may reject your setup.
Tax Comparison: LLC vs S-Corp at Various Income Levels
Single Filer
| Net Business Income | Total Tax as LLC (Schedule C) | Total Tax as S-Corp (50% salary) | Approx. Tax Saved |
|---|---|---|---|
| $50,000 profit | ~$11,300 (income tax + SE tax) | ~$7,900 (income tax + payroll tax) | ~$3,400 saved |
| $100,000 profit | ~$27,900 (income + SE tax) | ~$21,900 (income + payroll tax) | ~$6,000 saved |
| $200,000 profit | ~$60,700 (income + SE tax) | ~$53,700 (income + payroll tax) | ~$7,000 saved |
For a single taxpayer, the S-Corp strategy clearly saves a significant chunk once income rises into six figures. At $100K profit, roughly $6K less in total tax by using an S-Corp. At $200K, around $7K less. (The savings plateau or drop off at very high incomes in this example because Social Security tax caps out for the LLC as well.)
Married Filing Jointly
| Net Business Income | Total Tax as LLC (MFJ) | Total Tax as S-Corp (MFJ) | Tax Saved |
|---|---|---|---|
| $50,000 profit | ~$9,500 (income + SE tax) | ~$6,100 (income + payroll tax) | ~$3,400 |
| $100,000 profit | ~$22,600 (income + SE tax) | ~$15,900 (income + payroll tax) | ~$6,700 |
| $200,000 profit | ~$51,400 (income + SE tax) | ~$43,800 (income + payroll tax) | ~$7,600 |
Married couples benefit from lower income tax rates on a $100K or $200K income, but the self-employment tax hit is the same dollar amount. S-Corp savings are similarly substantial – around $7K saved at $200K profit in this scenario. All figures are estimates for illustration.
Sources: Tax calculations based on 2023 IRS tax rates and self-employment tax rules.
As shown, the LLC taxed as a default sole prop/partnership results in notably higher total taxes once income is sizable. The difference at $100K or $200K can easily fund other business needs or personal savings.
This is why many advisors suggest switching to S-Corp treatment around the point your profit exceeds what a reasonable salary would be. (It’s not worth it at very low profits because the administrative costs would outweigh the tax savings.)
State Tax Differences for LLCs
Federal taxes are just part of the story. State taxes and fees can make an LLC more or less attractive. Here are a few examples of state-specific treatments that business and rental owners should know:
| State | LLC Costs & Taxes | Notes |
|---|---|---|
| California | $800 annual LLC franchise tax (mandatory, even if LLC has no income) + gross receipts fee on LLCs earning > $250K (ranges from $900 to $11,790)​ | These fees are in addition to normal state income tax. California also imposes an $800 minimum tax on S-Corps, plus a 1.5% tax on S-Corp net income (instead of the gross receipts fee). High cost state for LLCs – many small landlords holding one property find the $800 fee outweighs any benefit. |
| New York |
$25–$4,500 annual LLC filing fee, based on New York gross income​. (For example, ~$500 fee if NY-source income is $500K.) Also, NY LLC formation requires an expensive publication of notices in newspapers (can cost $1,000+ in NYC). |
New York treats LLCs as pass-throughs by default (no entity income tax)​, but these fees add to the cost of doing business. S-Corps in NY generally don’t pay these LLC fees, but they file an S-Corp franchise tax (often minimal for small businesses) and have their own publication requirements if formed in NY. |
| Texas | No personal state income tax. LLCs and other entities are subject to Franchise Tax: 0% if revenue ≤ $1.23 million; above that, margins are taxed ~0.375% (for wholesalers/retail) to 0.75% (others)​. (The no-tax-due threshold doubles to $2.47 million starting 2024, making it even less likely small firms pay this tax.) | Texas is very business-friendly tax-wise. An LLC or S-Corp in Texas will likely pay $0 state tax if small or medium-sized, due to the high threshold. Just need to file the franchise tax report. |
| Florida | No personal income tax. No state franchise or privilege tax on LLCs. Only an annual report fee (~$139/year) to maintain an LLC​. | Florida LLCs don’t incur additional state tax, only this modest compliance fee. C-Corps in Florida do pay a state corporate income tax (5.5%), but LLC pass-through income is not taxed at the state level. |
Other states have their quirks: e.g. Tennessee and Texas call their franchise tax the “business privilege” or “margin” tax; Illinois and others require annual report fees for LLCs; some states (like New York, California) also charge LLCs for each member or other filing fees.
Always check your state’s LLC costs. In some places, the extra fees might make a simple sole proprietorship (or holding property in your own name with insurance) more cost-effective if the LLC’s liability protection is not critical for you.
The Real Real
LLCs are not “bad” – but they also aren’t a tax silver bullet.
For federal income taxes, an LLC won’t reduce what you owe (beyond the general perks available to all pass-throughs, like the QBI deduction).
For self-employment taxes, an LLC alone doesn’t help – you’d need an S-Corp election to see savings.
From a pure tax perspective, an LLC can be neutral or even slightly negative (due to state fees).
That’s why some say an LLC is “bad for taxes” – because people assume it magically lowers taxes when it doesn’t by default, and in certain states it adds costs.
However, an LLC’s flexibility allows you to choose a tax route (stay a disregarded pass-through, elect S-Corp, or even C-Corp) that best fits your situation.
It’s not that LLCs are bad, but rather they don’t automatically confer tax advantages. The smart move is to use the structure’s flexibility to your benefit when the time is right.
Pitfalls to Avoid
When considering an LLC for your business or property, watch out for these common pitfalls and misconceptions:
1. Assuming an LLC cuts your tax bill
Simply forming an LLC won’t reduce federal taxes. As highlighted, you’ll pay the same income and self-employment taxes as before​.
Don’t let the “Limited Liability Company” name mislead you – it’s about liability protection, not a tax reduction tool (unless you take further steps like S-Corp election).
2. Not Paying Estimated Tax Payments
New business owners are often surprised by the 15.3% self-employment tax on profits. If you’re an LLC owner, budget for these taxes in addition to income tax. Welcome to business.
If your profits grow, consider switching to S-Corp to avoid overpaying. Many LLC owners leave money on the table by not making an S-Corp election once it would save them money.
3. Not Paying Yourself a “Reasonable Salary”
If you do elect S-Corp status, you must pay yourself a fair wage for your work.
Underpaying yourself to skip payroll taxes is illegal and an IRS red flag. For instance, if your consulting LLC makes $150K and you take $5K salary and $145K as a distribution, expect trouble. Avoid this pitfall by researching typical salaries in your role or consulting a CPA.
4. Over-Complicating a Simple Rental Operation
Putting a single rental property into an LLC for liability reasons is common, but from a tax view it changes nothing (except adding costs in some states).
If you transfer property to an LLC, be mindful of property transfer taxes, mortgage due-on-sale clauses, or loss of homestead benefits – these are not tax pitfalls per se, but financial drawbacks unrelated to income taxes.
Some landlords might be better off with good insurance and no LLC if the extra fees and hassles outweigh the protection.
5. Ignoring State and Local Fees
As shown, states like CA, NY, MA, etc., have annual LLC fees or franchise taxes. Don’t form an LLC in such states without considering those costs. It can eat into your profits.
For example, paying $800 a year in CA on a small rental that nets $1,000/year wipes out 80% of your profit – a costly mistake if you expected a tax “benefit” that isn’t there.
FAQs
Get answers to common questions about LLCs and their tax implications.
Does forming an LLC save me money on taxes?
No, forming an LLC doesn’t reduce taxes by itself. Any savings come from electing S-Corp or C-Corp status, not from the LLC alone.
Do I still have to pay self-employment tax if I have an LLC?
Yes, if your LLC is taxed as a pass-through, you must pay self-employment tax on your profit. The only way to reduce it is by electing S-Corp and splitting wages and distributions.
I’m a truck driver/contractor – should I be an LLC or S-Corp?
Many independent contractors form an LLC and later elect S-Corp once profits pass about $50K–$100K. This can save on taxes but adds payroll and filing requirements, so compare the costs.
Does an LLC help reduce taxes on rental property income?
Usually, no. Rental income is often passive, so an LLC doesn’t lower federal taxes and mainly provides liability protection.
What about state taxes? Will an LLC help there?
An LLC doesn’t automatically reduce state taxes. Some states charge extra LLC fees, so check your local rules.
If LLCs don’t give tax breaks, why are they so popular?
They offer personal asset protection, flexible taxation, and simpler administration than corporations. You can start as a pass-through and switch to S-Corp later for potential savings.
Can I deduct more expenses through an LLC?
You can only deduct legitimate business expenses, same as any business. An LLC usually helps with clearer record-keeping, but it doesn’t create new write-offs.