Small business owners often choose the business structure LLC because of the many benefits they offer. A business can choose to organize as a corporation, sole proprietorship, partnership, or LLC. Owners should determine whether to form an LLC or another type of business structure based on what goals they want to achieve.
So, exactly what is an LLC good for? Determining whether or not you should form an LLC can rely heavily on the benefits doing so may provide. In this guide, we’ll take a closer look at LLCs and what they’re good for so you can decide if a Limited Liability Company is the right move for you.
What is an LLC?
A limited liability company (LLC), is a type of legal entity that can be formed to operate and own a business. LLCs are a hybrid structure that has the advantages of a partnership in its simplicity, flexibility, and tax advantages, and the liability protection of a corporation.
The owners of a limited liability corporation are called “members”. There can be one or more members of an LLC. There’s no limit to the number of members that can be part of an LLC.
The members of LLCs can be individuals or other businesses. The personal assets of these members are protected from the creditors of a business with a limited liability company.
How is an LLC Different from a Partnership?
A partnership is a structure that involves two or more individuals who share ownership in a business. The biggest difference between a partnership and LLC is protection from business debts. This asset protection is possible because LLCs are legally separate from their owners.
A business that is set up as a partnership isn’t a separate legal identity from the owners that own the business. Therefore, if the business accumulates business debts, its owners could be held personally responsible.
There are no documents that must be filed in the state that a partnership begins. When forming an LLC, the members must submit their articles of organization in the state where the business is organized. In addition, LLCs must register in each state that they operate in.
There are fees that must be paid to file these articles of organization in each state an LLC conducts business. Partnerships do not have to pay these fees, nor file articles of organization.
How is an LLC Different?
LLCs are formed with one or more business owners who file articles of organization in a state. An operating agreement is put together that governs how the business will be managed on a day-to-day basis. The membership interests or percentage of ownership are also determined.
Corporations are formed by filing articles of incorporation in the state that they are located. A Board of Directors is formed to oversee the corporate business and bylaws are created to create guidance for its operations. They may assign top-level managers to the business and hold regular meetings.
The members of a limited liability company have equity interest in the assets of the business. That’s because they made investments to join the company. In corporations, the owners are called shareholders and they have shares of stock.
Another one of the key differences between corporations and LLCs is how profits and losses are handled. For example, LLC profits and losses are passed through to the owners. Corporations will hold these profits and losses, conversely.
Who Should Consider an LLC?
Individuals who are running sole proprietorships or looking to start a business should consider forming an LLC. Protection for your personal assets is a huge benefit that sole proprietorships don’t offer to their owners.
Almost any type of business can be owned and run with LLCs. Depending on the state you do business in, you might have to form special professional LLCs.
Whether you have one owner or multiple owners, you can form an LLC for any business size. Commercial and rental property owners typically use LLCs to form their businesses.
Advantages of an LLC
LLCs can offer a variety of benefits when it comes to owning and operating your business. Below are some advantages you can expect to receive from an LLC.
An LLC gives all its owners protection for their personal assets. This is one of the most important LLC advantages. So as an LLC owner, you’re not held personally liable for business debts that are incurred. This protection of personal assets is not without some exceptions.
If you face lawsuits by your creditors or other companies, their attorneys will go after the assets of the LLC. For example, this would include the LLC’s bank account.
Owners of LLCs receive pass-through taxes. That means that the profits or losses from the business are passed through the business to become part of the owner’s personal income tax returns. An owner avoids double taxation by setting up the business as an LLC. Taxes from profits are taxed at the owner’s personal tax rate. Thus, it increases their personal taxable income.
In most cases, a single-member LLC is taxed the same way as a sole proprietorship. For example, the owner of the Internal Revenue Service (IRS) Schedule C is used to report the LLC’s profits, losses, and deductions and is filed with their personal returns.
If an LLC has more than one member, the taxes are treated as a partnership. So each member will report any profits or losses on their personal returns and their tax level is at their personal rates. LLCs with multiple members will report this on their Schedule K-1.
This all being said, an LLC has tax flexibility in being able to choose how they are taxed. For example, both single-member LLCs (SMLLCs) and multiple-member LLCs can choose to be taxed as a corporation if that’s what they decide is best.
To opt for this type of taxation, they must file with the internal revenue service a document called an election. Whether an LLC decides to be taxed as a C corporation or S corporation, the members generally work as employees of the business.
C corporation taxation works by paying taxes at the corporate tax rate on business profits. Personal tax rates are generally higher than corporate rates.
Using the treatment of S corporations, an LLC can pass through their taxes as explained above. If you decide to go with an S corp structure, your distributions aren’t subject to Medicare or social security taxes. S corporations can result in tax savings when using this taxation method.
As you may have gathered, an LLC structure offers more than just flexibility with taxation. Limited Liability companies are less rigid with the formalities found in corporations. LLCs don’t have a management structure that includes a board of directors who make the big decisions on business operations. These companies also have shareholders whom they must keep happy and hold regular meetings.
Members of an LLC use more informal methods of making business decisions. They can decide what’s best for their business, whether that’s to manage their business operations or hire outside managers to handle it. There are no shareholders that members must report to with limited liability companies.
This is particularly a benefit if the members aren’t experienced with running a business. An owner can hire competent managers to handle the day-to-day business needs instead of taking on those responsibilities themselves.
In some states, by default an LLC is member-managed. This is the case unless it is explicitly stated differently in the filing with the secretary of state or a similar agency.
Ease of Startup and Upkeep
Starting an LLC is relatively easy as there are a few pieces of paperwork and fees involved. States have very different variations in these fees and taxes.
For example, in California, you must pay a $70 fee when filing your articles of organization. In a state like Nevada, you will $425. The annual fees for maintaining an LLC will also vary in states.
The process is simple enough for small business owners to handle it on their own. Still, it might be a good idea to consider looking for legal or accounting help. Make sure your pool of attorneys or accountants that you’re considering has experience in LLCs.
Setting up LLCs is the simplest out of the different business entities that can be formed. You don’t have the administrative burdens found in corporations of having officers, directors, and shareholder meetings.
Despite the differences in fees and paperwork, starting up in a state is straightforward. Even if you choose to create an LLC in many states, it could be done without relying on attorneys to
Businesses that choose to form an LLC will give you more credibility. Your customers view your organization as a legitimate, real business. You and your partners have an official name that can be used.
Disadvantages of an LLC
LLCs offer many benefits that make them popular, particularly to small business owners. But there are drawbacks that you should be aware of before opting to operate as an LLC.
Limits to Liability
The asset protection of an LLC isn’t full proof so you could personally face liability in a lawsuit. For example, a judge may rule that your LLC structure is not adequate protection. Your liability could come as the result of actions such as not separating your business transactions properly.
The tax status by default for an LLC is the same as a partnership. Owners must file documentation if they want to be taxed as a corporation.
Members of an LLC are identified as self-employed because this default tax status makes the United States government determine that they work for the LLC. So members are personally responsible for paying self-employment tax (social security and medicare).
Implications of Management Turnover
Depending on the state, an LLC might have to dissolve if a member leaves or dies or the company goes bankrupt. The legal and financial obligations to terminate the business are then the responsibility of the remaining members. If these members want to continue doing business, they must start a new LLC.
Setting up a sole proprietorship or partnership is less expensive than forming and operating an LLC. Although an operating agreement is not required legally, it’s recommended to set one up layout of how the LLC will be governed.
An LLC must also pay annual fees and tax to the state they operate in. If an LLC operates in multiple states, it will be subject to those fees/taxes.
Not ideal for outside Investments
If you and your partners want to find outside investors, an LLC is the best option. Businesses that are looking for funding from venture capitalists in particular typically only fund corporations.
There are ownership restrictions such as not being able to issue stock in exchange for investor money In an LLC. An investor may receive LLC ownership interests when investing in an LLC, but this is much more complex.
How to Start an LLC
If you’re looking to start an LLC, below are the essential steps for getting your business up and running.
Step One: Choose a Name
To decide on the name, you should ensure it isn’t the same as an existing LLC in your state. Do a search to check if the name is available. You must also comply with state regulations in LLC names.
Step Two: Submit Articles of Organization
This document established you as an LLC. Some states have a standard form that you simply have to bill in the blanks. Others may require some things as the signature of all the owners.
Step Three: Decide on a Registered Agent
One person is typically required to act as the registered agent for an LLC in most states. This registered agent will represent the LLC and receive legal documentation if there’s a lawsuit.
Step Four: Publish a Notice of Intent
Search for information specifically for your state on whether this is required there or not. This is a legal notice that’s published in your local newspaper which reports your intent to form an LLC.
Step Five: Create an Operating Agreement
This document is not necessarily required in your state. But creating one can help avoid problems later on. An operating agreement outlines the rights and responsibilities of each owner of the LLC. It includes each owner’s voting power, percentage interest in the business, and schedule of owner’s meetings.
Bottom Line: Limited Liability Companies
If you have an existing sole proprietorship or partnership or are opening a small business, an LLC might be the right structure. Your personal assets are legally protected, offer tax benefits, simple to set up, have management flexibility, and give your business credibility. Consider these advantages against the disadvantages to weigh your options to make the best choice.