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Self-employed and missing out on major tax savings? You’re not alone. An analysis of IRS data found that freelancers overpaid their taxes by an average of $3,019 in 2022, often due to missed deductions and a lack of tax planning. Gig workers also tend to overpay, with tax bills coming in about 21% higher than necessary.
The good news? Taking a few strategic steps, like setting up an LLC and opening a SEP IRA, can help you reduce your tax burden and boost your retirement savings.
Here's how the LLC + SEP IRA combination can help you keep more of what you earn while building serious retirement wealth.
What’s an LLC?
As a freelancer, consultant, or independent contractor, you face unique risks that W-2 employees don't:
- Client disputes that could lead to lawsuits
- Professional liability if your work causes harm whether financial, physical, or structural
- Contract breaches that could put your personal assets at risk
An LLC creates a legal barrier between you and your business. A Limited Liability Company (LLC) is a business structure ideal for small business owners. It separates you from your business, meaning your personal assets, like your home or savings, are generally protected if the business faces legal issues or debts.
Tax Flexibility That Matters:
- Single Member LLC (Default): If it’s just you running the business, this is usually how your LLC is set up by default. It means your business income and expenses go right on your personal tax return, and you generally pay self-employment taxes on the profits, just like a sole proprietorship.
- Partnership: If an LLC has more than one owner, it’s usually treated as a partnership by default. That means the business itself isn’t taxed separately, each owner reports their share on their own tax return.
- Corporation: A business that is treated separately from its owners for taxes. It files its own tax forms and may have to pay taxes on its earnings. This includes two options:
- C Corporation: With this tax setup, the business pays taxes on its profits first. Then, if it gives money to owners as dividends, those owners pay taxes on that money too.
- S Corporation: With this tax setup, the business itself doesn’t pay taxes on profits. Instead, the profits “pass through” to the owners, who report them on their personal tax returns. Owners usually pay themselves a salary and can take additional profits as separate payments, which are taxed differently.
These are tax choices, not legal changes. Your LLC remains an LLC no matter how it’s taxed, and each option comes with pros and cons depending on how you plan to pay yourself and grow your business.
What This Means in Practice
With an LLC, your personal money and belongings like your home, savings, and investments are usually protected if your business gets sued or falls into debt. Unless you’ve personally agreed to be responsible (like signing a personal guarantee), only the money and property owned by the business are at risk. It can also help you look more professional, especially to bigger clients who prefer working with registered business entities.
That said, LLC protection isn’t absolute. There are exceptions for example, if you personally guarantee a loan, commit fraud, or are involved in something illegal. In those cases, a court could “pierce the corporate veil” and hold you personally responsible. Rules can vary by state, so it’s a good idea to check with a legal professional to see how this applies to you.
Pro tip: Many self-employed professionals start with the default option and consider S-Corp election as income grows.
What Can You Deduct as an LLC?
Running a business means spending money. The good news? A lot of those costs may be deductible, which could lower your taxable income and free up money for things that help your business grow.
Let’s break it down into two types of expenses:
Startup Expenses
These are the one-time costs that come with getting your LLC off the ground. Think of them as your setup costs before you officially open your doors. They might include:
- Legal and filing fees to register your business
- Market research to shape your business plan
- Product prototypes or test services
- Branding or website development
The IRS lets you deduct up to $5,000 of eligible startup costs in your first year. If you spend more than that, you may still be able to deduct a portion over time. Also, if you decide to sell your business down the road, any profit you make could be subject to capital gains tax, something to keep in mind as part of the bigger picture.
Operational Expenses
Once your business is up and running, you’ll have recurring costs to keep it going. These are known as operational expenses and may include:
- Rent for your office or storefront
- Utilities like electricity and internet
- Software and tools
- Employee wages or contractor payments
- Office supplies
These are the everyday expenses that help your business function, and many are tax-deductible.
Common Tax Write-Offs for LLCs
Understanding what your LLC can deduct can help you save big come tax time. Here are some of the most common write-offs:
- Payroll and contractor pay
- Startup costs (up to $5,000 in year one)
- Self-employment tax (you can deduct half)
- Employee benefits like health insurance
- Home office expenses (if you work from home)
- Rent or lease payments
- Business insurance
- Marketing and advertising
- Depreciation for equipment
- Utilities
- Licensing fees
- Business travel
- Business vehicle expenses
- Inventory that’s central to operations
Not Everything Is Deductible
The IRS only allows deductions for expenses that are ordinary and necessary for your type of business. That means some things don’t qualify, like:
- Personal purchases or lifestyle upgrades
- Fines or penalties
- Your daily commute
- Childcare
- Political donations
- Entertainment (unless it's business-related)
- Household expenses (unless part of your home is used exclusively for work)
By keeping good records and understanding what’s deductible, your LLC can run more efficiently and keep more money in the business.
