LLCs can give you the flexibility of a partnership with the liability protection of a corporation. Find out the advantages and disadvantages of LLC.
Choosing the right business formation has long-reaching repercussions. How you pay taxes, your personal liability, and the amount and type or regulations encountered are dependent on the way you form your business. One of the most common choices is a Limited Liability Company (LLC). LLCs share many of the same qualities as an S-Corp or C-Corp while enjoying more flexibility and requiring less paperwork. But that’s just an overview. Let’s look at some advantages and disadvantages of LLCs to help you choose the correct business structure for you.
The IRS does not consider an LLC to be a distinct separate entity for tax purposes. This means that, at least initially, the IRS will not tax the LLC directly. Instead, members of the LLC get to determine how they want to be taxed. There are several options:
- Single member LLC: This structure is taxed like a sole proprietorship. Profits or losses from the business are not taxed directly but instead are taxed through the single member’s personal federal tax return.
- Partners in an LLC: Members elect to be treated like a traditional partnership for tax purposes.
- LLC filing as a Corporation: The members of the organization may also choose to file as if they were corporation.
Generally, members of an LLC will create an Operating Agreement that outlines how the LLC will be treated for tax purposes. Some LLCs are automatically classified as corporations by the IRS, so be aware. Further information on how the IRS classifies some LLCs can be found at IRS.gov.
Compared with C-Corps or S-Corps, LLCs are very flexible. Once again, you’ll want to have an LLC Operating Agreement so you can create rules that govern your business. Otherwise, your company will be governed by the default rules in your state.
With less stringent requirements for compliance and less necessary paperwork, LLCs are easier to form and easier to keep in good legal standing.
Like corporations, LLCs provide their members protection from liability. This means that members are not personally liable for debts and often court judgments incurred by the LLC. Creditors are foreclosed from seeking the personal assets of the LLCs members. It is a meaningful shield not provided in a sole proprietorship or traditional partnership.
Unless you choose to be taxed like a corporation, LLCs are usually subject to self-employment taxes. This means that the profits of the LLC won’t be taxed at the corporate level, but will pass through to its members who will account for those profits on their personal federal tax returns. Oftentimes, these taxes are higher than they would be at the corporate level. Individual members will pay for federal items like Medicare and Social Security. For this reason, if you do choose to start an LLC, it’s a great idea to speak to a knowledgeable lawyer or accountant.
Confusion About Roles:
Whereas corporations have specific roles (like directors, managers, and employees), LLCs generally do not. This can make it difficult for the company and especially investors to know who’s in charge, who can sign certain contracts, etc. Some of this confusion can be avoided by creating an LLC Operating Agreement.
In many jurisdictions, if a member departs the LLC, the LLC ceases to exist. This is unlike a corporation whose identity is unaffected by the comings and goings of shareholders. Members of LLCs can combat this weakness in the Operating Agreement.
LLCs give you a great combination of flexibility and protection. They shield members from personal liability while affording them an array of tax options.
Of course, an LLC might not be right for your business. If you’re having reservations, check our article of the tax considerations of each business type. Then, once you feel you’ve made the right decision for your business, visit our Incorporation Center and form your business today. If you’re ready to get started, visit our LLC Map for a rundown of everything you’ll need in all fifty states. If you’d like more general information about starting a business, be sure to check out our guide.
Christina Dixon is actively involved in local and national bar associations. She is a member of the Council for the ABA Section of Litigation, the Denver and Colorado Bar Associations’ Legal Fee Committees and the Sam Cary Bar Association and National Bar Association. Christina has extensive experience in insurance.