If you’re starting a business or running your business as a sole proprietorship or partnership, you may want to consider forming a limited liability company (LLC). An LLC offers many benefits that make it popular among entrepreneurs.
Here we will provide you with all the advantages of an LLC that may make it a good option for your business, rather than the alternatives.
Personal Liability Protection
As the name implies, an LLC provides you with a certain amount of personal liability protection. The LLC is its own entity, separate from its owners, who are called members. This means that the LLC can have its own assets and debts and is solely responsible for its own obligations. You, as a member, are not personally liable for the obligations of the LLC.
So, if the LLC cannot pay its debts or is sued, you, as a member, are not liable and your personal assets are not at risk. You cannot be forced to pay obligations from your personal funds, nor can a creditor try to seize your other assets, including your home.
This differs from a sole proprietorship, in which the business owner and the business are considered one and the same. The owner is thus personally liable for the obligations of the business. The same applies to a general partnership. The partners are the business and are personally liable for its obligations.
Limits to personal liability protection for LLC members do exist, however. For example, if you are asked by a lender to personally guarantee a business loan, which is common, you then become personally liable for that loan.
Other limits can come from personally injuring someone in the course of business or from committing fraud.
Tax Flexibility
LLCs, by default, are considered pass-through entities, which means that profits and losses pass through to the member or members to be reported on their personal tax returns on a Schedule C. The LLC as an entity is not taxed.
If the LLC has only one member, it’s taxed as a sole proprietorship, which means it’s considered a disregarded entity by the IRS. The business does not file its own tax return or pay taxes.
If the LLC has more than one member, it’s taxed as a general partnership. This means that the LLC does file a tax return, but it’s for informational purposes only. The partnership does not pay taxes. The form filed is Form 1065, the U.S. Return of Partnership Income.
In both cases, the members of the LLC pay taxes on profits at their personal tax rate.
This differs from a corporation, which must pay corporate taxes at the corporate tax rate. Dividends that shareholders receive are also taxed, which is commonly referred to as double taxation.
This is one of the reasons that new entrepreneurs choose an LLC rather than a corporation.
However, LLCs also have the distinction of being able to choose how they will be taxed. They can elect to be taxed as either an S-Corporation or a C-Corporation by filing an election form with the IRS. The corporation status is for tax reporting purposes only.
In some cases, this can be beneficial because corporation owners are not subject to self-employment taxes, while LLC members are subject to those taxes. Being taxed as a corporation does, however, increase other administrative expenses, so the self-employment tax savings must be greater than the added expenses.
The choice of a tax status for your LLC should be made with the assistance of your tax advisor.
Simplicity
While forming an LLC does require filing forms to register your LLC with the state, it is much easier to form than a corporation.
A corporation also comes with the requirement to have a board of directors and to follow annual meeting and reporting requirements, while an LLC does not.
An LLC is simple to form and maintain and has much flexibility in terms of management. You can choose your management structure and assign roles and titles as you wish.
Flexible Profit Sharing and Distributions
In many types of businesses, profit-sharing and distribution percentages are based on the capital contributions of the owners. With an LLC you can choose any ownership structure and distribution allocation that you wish as long as all members agree.
For example, say you and another member each contribute $50,000 to start the business. While in a corporation, each owner would then hold 50% of the shares of the business, with an LLC you can choose any allocation of ownership and distributions that you want.
Perhaps you are going to have more of a role in managing the business. You might then be allocated 70% ownership and 70% of profit distributions, while the other member becomes a 30% owner. It’s up to you and the other member to decide.
You’ll define these percentages in an operating agreement, which is not required in most states but is critical. It will also contain provisions for member voting rights and procedures and specific rules for dispute resolution.
It’s a document best drafted with the help of an attorney to make sure the interests of the LLC and the members are protected.
When a Corporation is a Better Choice
Of course, an LLC is not always the best choice, and there is one particular situation in which a corporation may be more beneficial.
If you’re starting a business with high growth potential and plan to raise capital, a corporation might be for you. Investors look more favorably at corporations because ownership shares are more easily transferred than transferring ownership of an LLC.
It’s not impossible for an LLC to attract investors, but it can be more difficult. Speak with your attorney about your specific situation and capital-raising plans so that you can make the best choice for your business.
In Closing
So, as you can see, an LLC can be a great option for many entrepreneurs because of its many benefits. Limited liability protection is the advantage that it has over a sole proprietorship or partnership, and an LLC is simpler and has more tax flexibility than a corporation.
The choice depends on your plans and goals, so it’s a good idea to consult with an attorney and tax advisor who can help you to make the right decision.
Author: Carolyn Young