The most common and preferred type of business business for entrepreneurs and small business owners is a Limited Liability Company (LLC).
If your business currently operates as a sole proprietorship, changing to an LLC is in your best interest.
LLC shares many of the same qualities as a corporation while enjoying more flexibility and requiring less paperwork.
If you’re looking to form an LLC, contact me and I will be happy to answer any of your questions
Let’s look at some advantages and disadvantages of LLC to help you choose whether LLC is right for you…
1. LLC Offers Limited Liability Protection
As the name suggests, LLCs provide their members personal protection from liability.
What this means is that LLC members are not personally liable for business debts and judgments incurred by the LLC.
Further, creditors are limited from seeking the personal assets of LLC members due to liabilities that are incurred by the LLC.
This limited liability protection is a HUGE advantage over a regular partnership, where all members are personally liable for company debt.
Also, an LLC, since it is a separate entity, can apply for and build credit separately from the partners’ personal credit. This is another benefit to an LLC because it helps eliminate personal liability for business debt, as well as avoiding tension among partners regarding creditworthiness.
2. Simplicity: LLCs Require Less Paperwork
An LLC is much simpler to run than a Corporation.
LLCs will need to deal with less annual requirements and ongoing formalities than C-Corporation or S-Corporation.
While a Corporation requires officers, board of directors, regular director meetings and shareholder meetings, an LLC does not require these formalities.
Further, there is no need to get approval from a board before taking business action — which is one of the main benefits of an LLC. This simplicity and ease of doing business makes it just that much easier on business owners to operate an LLC.
Also, LLCs are free to make any organizational structure that is agreed on by the members. LLCs can be managed by the members or by managers — unlike Corporations which have a board of directors who oversee the major business decisions of the company and officers who manage the day-to-day affairs.
Furthermore, there are no restrictions on who can be an LLC member or how many members an LLC may have — unlike an S-Corporations.
For all of these reasons, an LLC is much simpler to run and operate than a Corporation.
3. Tax Benefits of LLC: Pass Through Taxation
LLCs can elect how they are taxed.
The IRS does not consider an LLC to be a separate entity for tax purposes.
This means that 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
Single Member LLC structure is by default called a “Disregarded Entity” by the IRS. A disregarded entity is treated the same as a sole proprietor, so your LLC’s income will be treated like personal income.
Profits or losses from the business are not taxed directly but instead are taxed through the single member’s personal federal tax return.
Partnership in an LLC
Members elect to be treated like a traditional “Partnership” for tax purposes. For businesses with multiple owners, LLC offers similar tax benefits, plus the added advantages of a corporate form.
If the members of an LLC do nothing, their LLC will be taxed as a partnership; however, they can elect for their LLC to be taxed as a Corporation — which is typically the preferred option.
LLC Filing as a Corporation
The members of the organization may also choose to file as if they were “Corporation.” If you choose Corporate taxation, your business will be taxed at a lower corporate rate for the first $75,000 of income.
If the members of an LLC want to keep the business’s profits in the LLC in order to facilitate the growth of the business, the preferred option is a C-Corporation.
Under this form, the LLC’s profits will only be subject to the beginning corporate tax rate of 15% — which is presumably less than the member’s personal marginal income tax rates. And if any of the members want to receive compensation, they can be paid W-2 wages for their business-related work efforts.
On the other hand, if the members of the LLC want to take all or some of the profits out of the business, the preferred election is an S-Corporation. Each member can receive his or her pro rate share of the LLC’s total bottom line profit as distributions of profit (taxed at their respective individual marginal income tax rates, but not subject to Self-Employment Tax).
All three of these options can have big advantages, depending on how much income you personally want to take and how much you plan to reinvest in your business.
Because everyone’s situation is unique, you should consult with a business lawyer to determine which option is best for you.
Generally, in order to enjoy the advantages of an LLC, members of an LLC will need an Operating Agreement that outlines how the LLC will be treated for tax purposes. An Operating Agreement is an agreement among LLC members that establishes the rules governing each member’s financial and managerial rights and duties.
An Operating Agreement is a declaration of the structure the member has chosen for the company, and sometimes is used to prove in court that the LLC structure is separate from that of the individual owner.
Another one of the benefits of a Limited Liability Company is that business profits are not separately federally taxed in addition to the member’s taxes. All of the profit passes through to the members, and is filed on each individual’s tax return.
This is a big advantage over a c corporation, where the profits are taxed and then distributions are re-taxed on the individuals’ returns. An LLC may still be charged state and local taxes, but in most states the profits are not separately taxed.
4. LLCs Enjoy Credibility
Forming an LLC can help a new business establish credibility with potential customers, employees, vendors and partners because they see you have made a formal commitment to your business.
5. LLCs Can Have Any Type of Members
Unlike corporations and partnerships, an LLC has flexibility in how it operates.
An LLC, in its Operating Agreement, can decide to distribute profits in proportions other than investment percentages.
In addition, one of the advantages of an LLC over an S Corp is that an LLC doesn’t have restrictions on the type and number of partners the way an S Corporation does. In fact, your members can even be foreign nationals or other companies, with no limit on the maximum number of members.
In a normal partnership, any member who wants to limit his or her liability can no longer be involved in the day to day management of the business.
One of the advantages of a Limited Liability Company is that all members are protected from personal liability without any restriction on their ability to manage and participate in the LLC.
6. Attractive to Foreign Investors
Although LLC’s are relatively new in many states of the US, they have been in operation overseas for over a century. Thus, when investors from other parts of the world are looking to invest, they are familiar and comfortable with the LLC structure.
This can also be added to the benefits of a limited liability company. In addition, investing in an LLC is less imposing than bigger corporations, so they provide a great place for foreign investors to enter the American market.
Benefits of LLC vs. Sole Proprietorship
The benefits of an LLC versus a sole proprietorship is mainly that LLC members are not personally responsible for company debts.
In a sole proprietorship and partnership, the owners are personally responsible for business debts.
What this means is that if the assets of the sole proprietorship or partnership cannot satisfy the debt, creditors can go after each owner’s personal bank account, house, car, etc. to make up the difference.
By contrast, if an LLC runs out of funds, the owners are usually not liable.
Further, it will be easier for an LLC to raise money. An LLC can accept new members by selling membership interests, and it can create new classes of membership interests with different voting or profit characteristics. Plus, investors will be assured that they are not personally liable for company debts.
Also, LLCs enjoy ease of ownership transfer. Ownership interest in an LLC can be sold to other members without disturbing the business.
On the other hand, the business of a sole proprietorship or partnership cannot be sold whole. Instead, each of its assets and intellectual property must be individually transferred. Also, new bank accounts and tax identification numbers are also required.
Benefits of LLC for Rental Property
There are some very good reasons to form an LLC for rental property.
The main reason people set up LLCs is to protect their personal assets. An LLC will protect you personally from being sued.
For example, if your tenant’s drunken cousin falls down the stairs and gets hurts, you could be liable. When the cousin sobers up, he figures he can sue you. If that happens, you’d be named in the lawsuit and would have to defend your own personal assets if you don’t have an LLC.
However, if your rental property is under an LLC, only the LLC’s assets would be liable.
While insurance could also protect your rental property, the catch is that your insurance might not cover the total costs you incur. If that happens, then your personal assets may be at risk. However, this won’t be an issue if your rental property is protected under an LLC.
So if you’re ever in doubt, make sure to have an LLC for your rental property.
LLC Tax Write Offs
What can you write off on you taxes as LLC business owner?
Having an LLC is attractive because of the simple “pass through” tax structure it provides. This means that the business income and deductions pass on to your own personal tax return.
When running an LLC, you may be entitled to a couple of deductions that could reduce your taxable income, including: cost of goods sold, equipment and supplies, auto expenses, office costs, and miscellaneous deductions.
It’s simple: the more tax deductions your business can legitimately take, the lower its taxable profit will be. When you’re totaling up your business’s expenses at the end of the year, don’t overlook these important business tax deductions.
Disadvantages of LLC
Formation and Ongoing Expenses of LLCs
To form an LLC, your business lawyer will prepare and file an Articles of Organization with the state.
Many states requires ongoing fees such franchise tax fees and some states will require an annual report of the LLC.
These fees are often not very expensive for small businesses, typically from $100 to $500.
Also, a few states, such as New York and Arizona, also require LLC owners to publish notice of the LLC formation in local newspapers for several weeks. This is typically a one-time fee.
Transfer of Ownership Could Be Harder for LLC
Ownership in an LLC can be harder to transfer than with a Corporation.
With Corporations, shares of stock can be sold to transfer ownership.
However with LLCs, all members must approve adding new owners or altering the ownership percentages of existing owners.
Self-Employment Taxes Disadvantage of LLC
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.
Sometimes, 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 form an LLC, it’s a great idea to speak to a knowledgeable business lawyer.
Limited Life Disadvantage of LLC
In some jurisdictions, if a member leaves an LLC, then the LLC will cease to exist.
This is unlike a Corporation whose identity is unaffected by the comings and goings of shareholders. Members of an LLC can deal and beat this issue in the Operating Agreement which a [contract lawyer can draft for you].
LLCs give you a great combination of flexibility and protection. They shield members from personal liability while affording them an array of tax options.
You should strongly consider forming an LLC if you are a one-person owner of your business or if you have other business partners.
If you still have questions about whether an LLC is right for you, then feel free to contact me, Sam Mollaei, Esq., at [email protected] or call 818-925-0002 and I can help you decide whether an LLC is right for you.