Passthrough LLC Tax Savings for Side Businesses
Complete Guide 2025
This guide covers how a passthrough LLC can help with taxes on a small side business, such as a Shopify store with around $5,000 in annual sales. It provides liability protection and lets income pass through to your personal return, making it easier to claim deductions. We'll explain the structure, key tax benefits, examples, and setup basics.
Last Updated: November 2025
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What Is a Passthrough LLC?
An LLC gives you liability protection without the tax complexity of a corporation. By default, most LLCs are treated as "passthrough" entities—meaning your business profits flow directly to your personal tax return. No corporate-level taxes. Single-member LLCs file on Schedule C (just like a sole proprietorship), while multi-member LLCs file as partnerships on Schedule E.
The big win? You avoid double taxation entirely. You can take business deductions right on your personal return, and you might qualify for the Qualified Business Income (QBI) deduction—that's up to 20% off your eligible income under Section 199A. For 2025, the full deduction applies if your taxable income is under $197,300 (single) or $394,600 (married filing jointly). Above those thresholds, the deduction phases out gradually.
Tax Benefits for a Small Side Business
If you're running a small side business—say a Shopify store pulling in around $5,000 a year—the real value comes from turning business expenses into tax deductions. Here's what you can write off:
Business Expense Deductions
Subtract costs such as inventory, shipping, and platform fees. Other common ones include:
- Home Office: Got a dedicated workspace? You can deduct a portion of your rent, utilities, and similar costs. You can use the regular method (calculate based on square footage) or the simplified method ($5 per square foot, capped at $1,500).
- Vehicle Use: Making deliveries or running business errands? Track your miles and deduct at 70 cents per mile (2025 rate), or use actual expenses. Just keep a log—the IRS will want proof.
- Phone and Internet: If you use these for business, deduct the percentage used for work.
- Supplies and Equipment: Office supplies, tools, and equipment under $2,500 can be fully deducted in the year you buy them. Bigger purchases might need to be depreciated over time.
- Other common deductions: Advertising costs, professional services (like legal or accounting), business travel, 50% of business meals, and business insurance.
QBI Deduction
A potential 20% reduction on qualified income for those under the income thresholds.
Managing Self-Employment Taxes
As a sole proprietor or single-member LLC, you'll pay 15.3% self-employment tax on your net profits. But here's a potential workaround: if your business grows, you can elect S-corp status. That lets you take a "reasonable salary" (which gets hit with payroll taxes) and then take the rest as distributions—which aren't subject to self-employment tax. This can save you money once your profits are higher.
Liability Protection
Shields personal assets from business issues, without added corporate taxes.
Keep in mind: Setting up an LLC isn't free. State filing fees range from about $50 to $800, and you'll have ongoing annual fees. For very small businesses, make sure the tax benefits outweigh these costs.
Real-World Example: A $5,000 Shopify Store
Let's say you run a small Shopify store selling custom items. Here's how the numbers break down:
- Gross Sales: $5,000
- Expenses: $2,500
- Inventory: $1,200
- Fees: $300
- Shipping: $300
- Marketing: $200
- Home office: $200
- Mileage: $150
- Phone/internet: $150
- Net Profit: $2,500
As a Sole Proprietorship (No LLC)
You'd report the $2,500 profit on Schedule C. At a 22% federal tax bracket, that's about $550 in income tax. Add in self-employment tax (around $383, though half is deductible), and you're looking at roughly $850 total before the QBI deduction kicks in. The QBI deduction could knock off another $500 (20% of $2,500).
As a Passthrough LLC
Tax-wise, it's the same as a sole proprietorship—you still file on Schedule C and get the same deductions. The difference? You get liability protection. If someone sues your business, your personal assets are shielded.
With S-Corp Election
If you elect S-corp status, you'd pay yourself a reasonable salary of, say, $1,000 (subject to payroll taxes of about $153). The remaining $1,500 comes out as distributions, which aren't subject to self-employment tax. That could save you around $230, though you'll need to factor in the added admin costs (payroll processing, more complex tax filing).
For 2025, the standard deduction is $15,750 if you're single, or $31,500 if you're married filing jointly. Your actual tax savings will depend on your specific situation—use our tax calculator to get personalized estimates.
Step-by-Step Setup Guide
1. Select Your State
You'll file your LLC formation paperwork with your state's secretary of state office. Fees vary widely—some states charge as little as $50, others can be $800 or more.
2. Choose a Name
Pick a unique name that includes "LLC" (or "Limited Liability Company"). Most states let you check name availability online before you file.
3. File Articles of Organization
This is the main formation document. You'll need to provide your business address, registered agent info, and pay the filing fee.
4. Obtain an EIN
Get an Employer Identification Number (EIN) from the IRS—it's free and takes just a few minutes online. You'll need this for tax purposes and to open a business bank account.
5. Draft an Operating Agreement
Even though it's not always required by law, an operating agreement is a good idea. It outlines how your LLC will operate, which helps protect your liability status and clarifies things if you add partners later.
6. Make Tax Elections
By default, your LLC is treated as a passthrough entity. If you want S-corp treatment instead, you'll need to file Form 2553 with the IRS—and do it within 75 days of formation or the start of the tax year.
7. Set Up Banking
Open a separate business bank account. This keeps your business finances separate from personal ones, which is important for liability protection and makes tax time much easier.
8. Handle Recordkeeping and Filing
Keep track of all your business expenses (accounting software helps here). For tax filing, you'll report everything on your personal return using Schedule C (or Form 1120S if you elected S-corp status).
9. Annual Compliance
Most states require annual reports and ongoing fees to keep your LLC in good standing. Mark your calendar so you don't miss these deadlines.
Once your LLC is set up, update your Shopify account (or whatever platform you use) with your LLC information. This helps ensure everything is properly documented for tax purposes.
When to Use This Structure
An LLC makes sense if your business is growing, involves any real risk (like selling products that could cause harm), or if you're likely to qualify for the QBI deduction. For truly tiny side hustles with minimal risk, a simple sole proprietorship might be easier and cheaper to maintain.
Once you've got your business structure sorted, don't forget about other tax strategies. Check out our guides on retirement contributions and other tax optimization strategies to build a complete tax plan.