Forming a limited liability company can be the perfect strategy for a business. There’s areason that it’s been the most common business entity in the US for the past 20 years.
One of the main reasons that a business or a group of people, form LLCs is to protect personal assets. Just as it sounds, there’s limited liability for owners of the business. It’s hands-off for the property they personally own.
As with every decision made for businesses, there are many more things to consider before taking this step. Of course, paperwork is involved. There may be tax implications that are advantageous, or not. There are different types of membership structures.
You can’t think about those considerations until you’ve gathered information. That way you can make comparisons and determine what’s best for you.
You can weigh the advantages and disadvantages, and see if the pros outweigh the cons. Or vice versa. For each individual business, there’s a business structure that is right for it.
What is a Limited Liability Company?
LLC’s limit the personal liability of business owners or partners. It protects their assets. It is a business structure that can have one owner, such as a sole proprietor, or any number of members.
LLC’s are taxed in a special way. When the owners file tax returns, business income is passed through to become part of the owner’s income. You can make money or lose money. If you need expert advice, you can seek help creating an LLC by using a website like CorpNet.
The Pros of an LLC
Akalp said that there are many advantages to setting up an LLC as opposed to operating as a sole proprietorship. In many cases, an LLC is the best choice.
“The main pros, in my opinion, are protecting personal assets, tax flexibility and gaining credibility,” Akalp said. “Since an LLC is its own legal entity if someone sues the company or it gets into financial debt, the owner’s assets are generally protected.”
“To maintain that asset protection, it’s essential that the owners keep personal and business activity and finances separate, they avoid engaging in fraudulent activity, they pay their taxes and filing fees onetime and they stay up to date on all compliance formalities needed to keep their LLC in good standing,” she added.
Akalp also went into more depth about tax flexibility and business credibility.
“By default, an LLC is considered the same tax-paying entity as its owner,” Akalp explained. “Income and losses pass through to the owner’s personal tax return and profits are subject to self-employment tax.”
“Online Sole proprietorships, LLCs, however, may elect to be treated as an S Corporation which can lead to tax savings in some situations.”
“Having an LLC behind a company name may make it look more professional to prospective clients, vendors, partners and investors,” Akalp said. “Many people perceive ‘LLC’ behind a company name as having a business that is more capable or professional.”
Here is more info about the benefits of having a limited liability company:
Filing LLC documents or paperwork is simple with fill-in-the-blanks forms at Secretary of State websites. You need a separate bank account and credit cards.
Limited Liability Protection
Limited Liability means an owner is protected from losing personal assets.
Flexible Membership Numbers
You can form a single-member LLC or have two or more members. There is no limit to members.
Fewer State-Imposed Compliance Requirements
State requirements are clearly defined. Basically, you need Articles of Organization, an Operating Agreement, and a Registered Agent.
The LLC has pass-through taxation at the business entity level. That means that you bypass corporate income tax. The profits or losses are reported within the business owner’s personal income tax filing.
Credibility of Having a Limited Liability Company
Having the LLC as part of the business name makes a statement. It adds credibility to the business name as a business that has a formal structure.
Deductions on Healthcare
The LLC can deduct the cost of medical insurance for employees who are not members of the LLC. If the LLC is set up to run and be taxed as an S Corp, the owners can take personal income tax deductions on premiums that are paid. If you’re a single-member LLC you can deduct the cost of your individual health insurance.
Flexibility of Management Structure
The LLC can be manager-managed or member-managed. The number of LLC members is unlimited.
Revenues for Members
Revenues for members can be placed into a living trust. The living trust can be a “member” of the LLC. Remember that a trust is a legal document that establishes ownership over assets, using a grantor and trustee. If the grantor dies, the monies in the trust can be transferred to the trustees, avoiding the probate process.
Ease of Cash Distribution
Members or owners can take money from the company profit account. They can do this in lieu of having a salary.
Deduction of Losses
If the LLC loses money, the loss can be deducted as a business loss on the personal tax return. It can help you save money on taxes.
The Cons of an LLC
Is an LLC best for you? There are also downsides to creating an LLC. As a business owner, it’s time to start a list, pros, and cons LLC.
“Generally speaking, no there are no limits of protection for an LLC,” Akalp said. “However, for maximum protection one may want to consider a corporation.”
“The LLC is more of a hybrid of a corporation and sole proprietorship,” she explained, “While still offering great asset protection as long as the LLC is in compliance, the corporation does go a step further – So really it would depend on the type of business and liabilities associated with that business.”
Here’s a look at the cons:
Annual reports must be filed, along with renewal filing fees, which can be high. The fees vary from state to state. If there are any changes to infrastructure, the entire LLC business entity may need to be refiled.
Difficulty Transferring Business Ownership
A transfer of owners may require unanimous agreement from all members. The way LLC business ownership is to be transferred is spelled out in the LLC Articles of Organization.
Separate Personal and Business Records
Profit or loss from the LLC must be reported on the owner’s or owner’s personal tax return. All business records related to the LLC must be kept separately. The business should have a separate bank account and credit cards.
Limits to LLC Protection
Although personal assets are protected, owners or members of an LLC can be held accountable for business losses. Business assets can be at risk. This can happen if a member gives a personal guarantee for a business loan or debt. Protection may be limited by the bad acts of an owner or member – such as a member who commits fraud or a crime against the LLC, or if a member personally damages an individual.
Limited Options for Investment
The only way someone can invest in the LLC is by becoming a contributing member or becoming an owner. An LLC can’t issue shares.
Exposure of Profits to Social Security and Medicare Taxes
If the LLC earns a profit, that amount will be added to the owner’s income on tax returns. Social security and Medicare taxes will be assessed.
An LLC is regulated by state statute.
Pros and Cons of an LLC vs Corporation Business Structure
Here’s a quick look at the advantages and disadvantages between each type, an LLC and a Corporation (Inc.) business. What’s the difference?
First, a definition of a Corporation also called a C Corporation. A C Corporation is a legal structure in which the shareholders, are taxed separately from the C corp.
C Corps are the primary kind of Corporation. There are also S corps. To learn more about an S corporation, see below.
Pros of an LLCs vs Corporation
Profits are reported on the owner’s tax returns and taxed at the owner’s tax rate (self-employment tax rate).
The management structure is set up as desired in Articles of Organization.
LLC is owned by members.
Cons of an LLCs vs Corporation
Corporation profits are subject to corporate tax rates. C corporations are subject to double taxation. The C corp is subject to corporate income taxation. The income of a C corporation is also passed through to shareholders, who are taxed. The C corp pays taxes on earnings before the earnings are distributed to shareholders as dividends. The dividends can be reinvested in the company at a lower corporate tax rate.
Corporation business structure must have a board of directors, officers, and shareholders. The board of directors is voted on by shareholders. There must be annual meetings.
The corporation is owned by shareholders.
A C corporation can also limit the liability of investors. The most an investor can be liable for if a C corporation fails is the amount the person has invested.
Pros and Cons of an LLCs vs S Corps
Here’s a quick look at each type, with advantages and disadvantages for small business owners. What’s the difference between an LLC and S-Corp?
First, let’s differentiate between an S Corp and a C corp. An S corp may also be called an S subchapter.
S corporations have to meet specific IRS guidelines that make them different than a C corp:
- The S corp must be incorporated domestically.
- S corporations can have only one kind of stock.
- S corporations can have no more than 100 shareholders.
- The shareholders in S corporations can NOT be partnerships, corporations or nonresident aliens.
If each of those guidelines is met, the S corporation may pass income (or losses) directly to shareholders. The S corp can pass income to shareholders without paying federal corporate taxes.
In other words, the S corporation qualification gives the business the benefits of corporation. And one of the S corporation benefits is that is enjoys exemption from federal taxes.
Shareholders of an S corp must report income or loss on individual tax return documents.
Pros of an LLCs vs S Corps
- LLCs have unlimited owners. Membership interests are important.
- LLCs have flexibility on how business is set up and run.
- LLC’s profits are taxed on an individual tax return.
Cons of an LLCs vs S Corps
- S corporation must be organized with a board of directors.
- S corporation has strict rules about required meetings and records of meetings.
- The state filing fees for S corporations are higher than LLC state filing fees.
- S corporations can have shareholders who are individuals, specific trusts or estates, or tax-exempt organizations.
- S corporation shareholders are taxed on profits received from the S corporation as part of income taxation. The S corporation earnings are taxed (double taxation).
Pros and Cons of an LLC vs Sole Proprietorship
Are LLCs a good option for a sole proprietor? What are the tax requirements? Tax liability? If you’re self-employed, should you form an LLC?
The short answer? If you need liability protection, consider an LLC. Liability protection is the number one reason for forming an LLC, whether it’s a sole owner or unlimited owners.
Here’s a quick look:
Pros of an LLC vs Sole Proprietorship
With an LLC the sole owner’s personal assets are protected.
A sole owner LLC can be taxed on LLC profit on personal tax return as taxable income, not subject to self-employment taxes.
Easier to separate business and personal accounts, since an LLC requires a dedicated bank account.
A loss from the LLC won’t affect your personal credit score.
Cons of a Single Member LLC vs Sole Proprietorship
As a sole proprietorship, you can be held responsible for liabilities.
A sole proprietorship must file a Schedule C for profit and loss and pay self-employment taxes.
Paperwork must be filed, with fees, as per state regulations. You must file Articles of Organization and Operating Agreement, along with required fees.
Is A Limited Liability Company a Good Idea?
Well, yes and no. It depends on your business goals and your preference for business structure.
You must weigh the pros and cons and decide if an LLC is the best option for you. It’s not the best option for all businesses.
But for many businesses, the choice to form an LLC is as simple as the need to protect the personal assets of an owner or owner. In those cases, forming an LLC for tax purposes is a secondary reason.
Here are the main reasons a business owner would opt to form a Limited Liability Company:
- Protect Personal Assets
- For tax purposes.
- To have flexibility in business structures.
How many owners can an LLC have?
A Limited Liability Company can have an unlimited number of members.
Should my business be a Corporation or an LLC?
You could argue that it’s easier for an individual to become part of a corporation by becoming one of its shareholders. And in that way a corporation can grow financially.
With an LLC, you can’t issue shares for shareholders. You don’t have shareholders. Instead of relying on shareholders, you need to attract outsiders who can invest in your company by becoming co-owner or contributing members.
Which one gives you the biggest break on taxes. I think we all know the answer to that one. Although it may seem that corporations or LLCs are getting breaks on taxes, you’ll pay somewhere. No business entities escape paying taxes.
For a definitive answer on which type of entity is best for you, consult a person who is an expert in taxes for businesses.
An LLC has been the most common type of business entity established in the US for the past 20 years. But the primary reason for choosing this type of entity, instead of forming corporations, is to protect assets.
Should I elect for my LLC to be taxed as an S Corp?
As you consider that option, here’s a term that will help: QBI, or qualified business income. QBI is net income, not gross income. And this is important as you consider choosing taxation as an S corp.
Since an s corp is a pass-through entity, you can deduct up to 20% of QBI. In other words, the s corp taxation guidelines allow the owner to take the 20% QBI deduction on business income.
If the LLC is taxed as an S corp, the business owner pays self-employment tax only on employment income.
Do LLCs pay more taxes than sole proprietorships?
A single-member LLC is taxed as a sole proprietorship.
A multiple-member LLC of two people is taxed as a partnership. The partnership files Form 1065 and each member of the partnership files a Schedule K-1.
LLC members are taxed based on their share of the LLC income. Each member must also pay self-employment tax.