A limited liability company (LLC) is a popular option when a startup chooses a business legal structure. An LLC is flexible, giving you taxation options and flexibility in the number of owners allowed. However, an LLC’s most compelling quality is its ability to limit personal liability if your business is sued or files for bankruptcy. Read on to learn more about this business structure, its benefits and disadvantages, and how to start one.
What is an LLC?
An LLC is a hybrid legal entity with the characteristics of a corporation, partnership and sole proprietorship.
“LLCs are just another entity type to protect the business owners,” said attorney Ryan Gordon.
Typically, LLCs are highly advantageous for business owners. They provide the same liability protection as corporations without requiring board meetings, corporate recordkeeping, or other tedious paperwork and events.
A business of any size can be an LLC, further adding to their flexibility. An LLC is a popular and flexible business legal structure, especially for small companies and startups.
What are the benefits of an LLC?
An LLC offers several benefits for businesses and owners, including the following:
- It protects owners’ assets. An LLC’s most significant benefit is protecting its owners’ personal assets if the business faces legal issues. Suppose your business is hit with a lawsuit. If your business is structured as an LLC, your assets are protected from any judgments imposed on the business. If your business can’t afford to pay the judgment, you, as a business owner, won’t be forced to pay the money from your personal finances.
- It offers management flexibility. Another crucial benefit is flexibility in how the business’s management team is structured. An LLC can either be member-managed, meaning owners handle day-to-day responsibilities, or manager-managed, meaning the owners bring in someone from the outside to handle the daily aspects of running the business. An LLC doesn’t limit how many owners a business can have; it allows you to see how profits are divided among the owners based on the operating agreement. “The LLC’s operating agreement provides the framework for how the company will be run, the relationships between the managers and members of the company, the plan for allocating profits, and other critical information pertaining to the operations of the LLC,” said Paolo De Jesus Jr., co-managing partner at Romano Law.
- It doesn’t require much paperwork. Also, if you’re not a big fan of paperwork, an LLC is worth considering because it requires much less documentation and administrative procedures than other business structures.
What are the disadvantages of an LLC?
The disadvantages of an LLC are minor compared to its benefits. If you own your business alone, forming an LLC can sometimes be more costly than maintaining sole proprietor status. You may need to pay annual reporting and franchise tax fees that wouldn’t apply with a sole proprietorship. And if your LLC is a partnership, transferring ownership shares might take more work than with an S corporation or C corporation.
Of course, you can avoid the latter problem if you register your LLC as an S corporation or C corporation. Doing so comes with the disadvantage of filing even more paperwork, though depending on your financial situation, this transition may lower your taxes. That could make the extra paperwork well worth your while.
How are LLCs taxed?
The federal government references LLCs as a “disregarded entity.” When you choose this particular business structure, the IRS taxes you as a sole proprietorship (if you’re a single-member LLC), a partnership (if you have more than one member) or a corporation (either as an S corporation or a C corporation, if that’s what you elect). Once this selection is made, the business calculates taxes based on those tax rules for the IRS and then prepares an LLC return for the state where they do business.
The benefit of this taxation structure is that LLCs are not subject to separate federal taxes unless the LLC is a C-corp. This is because the LLC’s profits and losses are passed to each owner, who then submits that info with their personal income tax return. This “flow-through” structure avoids the double taxation that corporations experience where the business pays taxes on profits, which are then taxed again when the business owner pays personal income tax.
However, business owners must pay self-employment taxes and may find themselves in a higher tax bracket. In such instances, they may be able to save money by electing to be taxed as an S-corp.
“It is actually possible for an LLC to also be an S-corp for the purposes of taxation,” Gordon said. “LLCs may also be taxed as partnerships, and partnership taxation is actually the default classification of an LLC for tax purposes.”