Crypto Taxes and Accounting

Crypto LLCs: How They Work & When to Use Them

Published
August 1, 2022
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    Most cryptocurrency traders and investors report their transactions on Form 1040, but a corporate structure could be beneficial in some cases. For example, a mining pool might use a corporate structure to write off expenses and clearly lay out the tax obligations of each owner. Or, a token issuer might use an LLC to limit the owners' personal liability.

    Let's take a look at how LLCs work, their tax benefits, and alternative corporate structures.

    Most crypto traders and investors report transactions on Form 1040, but a corporate entity may be beneficial in some cases.

    What is an LLC?

    A limited liability company, or LLC, is a legal structure that provides liability protection and other benefits to business owners. Their simplicity and low cost make them a popular option for everything from consultancies to real estate projects. And recently, they've become a popular option for crypto traders, investors, miners, and crypto businesses.

    Most states charge between $40 and $500 to register an LLC, along with recurring annual fees. In addition, a registered agent must accept legal documents and tax notices on the LLC's behalf and may charge an additional yearly fee. The LLC may incur fees for legal fees, banking, tax preparation, and other corporate costs.

    Crypto LLC
    Forming an LLC typically involves five steps. Source: NOLO

    While you can form an LLC in any state, Wyoming has the most progressive cryptocurrency legislation. The state legally recognizes digital assets as intangible property, meaning that all laws governing property apply to cryptocurrencies. In addition, the state's laws permit crypto banking and allow anonymous LLCs with enhanced protections.

    Crypto LLC Pros & Cons

    Pros

    • Write-Offs – Individuals operating a business can write off expenses and casualty losses on Schedule C. While you don't need an LLC, keeping personal and business expenses separate with a separate entity and bank account is much easier.
    • Liabilities – LLC owners aren't personally liable for business debts or obligations. The only exceptions occur when the corporate veil is pierced with violations, such as a failure to keep separate books for personal versus business expenses.
    • Privacy – Wyoming and other states permit anonymous LLCs, where the owner's name isn't specified in a state's public database. Again, there are ways to access the owner's identity, but it requires a hurdle that's somewhat higher to clear.

    Cons

    • Cost – LLCs involve a high ongoing cost and don't inherently generate any tax savings that individuals couldn't access. As a result, you could end up with fewer profits after expenses than you would if you filed as an individual on Form 1040 and Schedule C.
    • Complexity – Multi-member LLCs are relatively complex to set up and may necessitate the help of lawyers or accountants in the short-term and on an ongoing basis. As a result, many people find them too complex if there's a more accessible alternative.

    How LLC Taxes Work

    LLCs are pass-through entities, meaning profits flow to owners' tax returns. As a result, they don't inherently generate any tax benefits that wouldn't otherwise be available to an individual. Instead, they provide a more convenient way to separate personal and business assets, assign profits to multiple owners, and protect against liability.

    That said, single-member and multi-member LLCs have slightly different tax treatments:

    • Single-Member LLCs – Single-member LLCs must report profits or losses on the owner's individual tax return (Form 1040). The IRS doesn't recognize single-member LLCs as being separate from the individual.
    • Multi-member LLCs – Multi-member LLCs typically have an operating agreement that defines how profits and losses flow to each owner. Each owner owes tax on their portion of the profits or losses. The IRS also requires the LLC to file Form 1065 and provide each owner with a Schedule K-1 that details their share.

    Fortunately, crypto tax software has made it easier than ever to file taxes. ZenLedger aggregates transactions across exchanges and wallets, computes capital gains and losses, and completes the IRS forms you must file each year. And we support an industry-leading 400+ exchanges, 100+ DeFi protocols, and 10+ NFT platforms. Try it today!

    Alternatives to Consider

    LLCs are the simplest and cheapest corporate structure for most small businesses, but C Corporations and S Corporations are two popular alternatives. While these corporations involve significantly higher costs, they might generate tax savings or open the door to other possibilities over the long term (e.g., selling shares to the public).

    • C Corporations – C Corporations are separate entities that file and pay their own taxes. They may retain any profits or distribute them to shareholders as dividends (Form 1099-DIV). In addition, they can issue shares to any new owners and are the only vehicle that can go public on a stock exchange.
    • S Corporations – S Corporations are a unique pass-through entity that blends the benefits of a C Corp and LLC. The entity files its own tax returns like a C Corp but may pass income through to the owners like an LLC. However, they cannot issue shares to many owners and have other limitations.

    If unsure of the best option for your crypto business, consider talking to a crypto-friendly accountant or lawyer to help you decide. The best choice often depends on the individual business, owners, and long-term objectives. And, since some structures are irreversible, it's worth considering your options before committing to a choice.

    If you’re looking to reduce your tax burden, you may be better off exploring different strategies, such as tax loss harvesting or holding crypto assets over a longer period of time. If you’re operating a business, it’s also a good idea to talk with your accountant or tax professional to find ways to strategically write off expenses and reduce taxable income.

    The Bottom Line

    Crypto traders, investors, miners, and businesses may want to consider an LLC or other corporate structures to streamline their taxes and protect their assets. While they don't always help save on taxes, they can help keep personal and business assets separate, assign ownership to multiple parties, and protect owners' personal assets.

    If you trade cryptocurrencies, ZenLedger can help you streamline your taxes and identify opportunities to save. Sign up for free today!

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