How to calculate tax deduction for first year of opening an LLC when funding it from your salary?

Question

I need help understanding how it works when one opens an LLC in the United States, funds its activity from a job he or she does. For example the individual earns 200,000 dollars in a day job and pays 30% federal income taxes, but when she opens a business and funds about 20,000 dollars a year from her net income, what happens during tax season?

How can she claim deduction assuming she uses her phone bill of 100$ a month, home office of 100 sq feet, car for business purposes cum job purposes 50%-50% basis 200% gas/month and 500$ car loan per month. She travels in flights for business trips 4 times a year paying 500$ each trip. She pays her mortgage of 3000$ on her 2000 sq foot home but uses a home office room of 100 square feet for the LLC

She barely made 1000$ the first year from her business.

Second case is she makes exactly 20,000 dollars from her business and breaks even. What kind of taxes does she pay?

Who to calculate what she can write off? What happens to the 30% federal income tax on her day job income ? Does it get reduced? Im trying to learn doing the math and not just use an online tool. Thank you.

Answer 1

Big assumption here: based on your question this is a single-member LLC treated as a disregarded entity. It doesn't matter how the LLC is funded (from her day job, from savings, etc.), it won't impact the profit/loss of the business.

Refer to IRS Pub. 535 and IRS Pub. 946. These provide a solid overview of how to calculate business expenses. It's a very complex topic, and different items are calculated in different ways (for example, cars and travel can be complicated depending on the exact situation).

What ends up happening on a high level is this:

• The $200,000 salary (or realistically, whatever the number in Box 1 on her Form W-2 is, since it's likely different from the quoted salary) goes on line 1a of Form 1040.
• The LLC's profit/loss is calculated on Schedule C and flows through to Schedule 1 and Schedule SE.
• Self-employment taxes are calculated on Schedule SE, which flows to Schedule 2.
• If applicable, she'll also calculate her Qualified Business Income deduction on Form 8995.
• There are other steps as well, but only after all of that will her income tax be calculated.

Answer 2

In additional to Stan's technical answer, some more points to consider:

• LLCs in the US tax law are generally disregarded unless explicitly chosen to be treated as corporations. That means that for a single-member LLC the business would be treated the same way as a sole proprietorship, and reported using Schedule C. You may want to consider whether LLC is at all needed (i.e.: liability protection is desired), otherwise it may be a waste of money.

• LLC on its own has zero tax benefits (due to the point above - from tax perspective it is disregarded).

• Businesses that are not profitable over time may be considered by the IRS as hobbies, in which case deductions may be limited. See this IRS tax tip.

• Not everything can be deducted, and some deductions are limited or have strings attached. For example, "100 sqft home office" has to be used exclusively for business. Travel expenses need to be substantiated and deductions may be limited (e.g.: meals and such). Car deductions may require contemporary travel logs, etc. If you're talking about thousands of dollars of expenses a year - better consult a tax adviser (EA/CPA licensed in your State) to know the rules and plan accordingly.

• Deducting business losses from other earned income is not always allowed. It has to be an "active" business. Rentals, for example, often times are considered passive activities, and rental loss deductions from other income are limited.

Bottom line, someone who earns $200K/yr at their job and wants to start a side business would be prudent to engage a professional tax adviser.