Starting a limited liability company (LLC) can provide important legal and tax benefits for many small business owners. An LLC combines aspects of a partnership and corporation to provide the liability protection of a corporation with the tax flexibility of a partnership or sole proprietorship. Here are some of the top reasons why starting an LLC may be the right choice for your business.
Limited liability protection
One of the biggest reasons to start an LLC is to gain personal liability protection. With an LLC, your personal assets are separated from the business. This means if the business is sued or faces claims against it, your personal assets like your house, car, savings, etc. are not put at risk. Creditors can only go after the LLC’s assets and not the owner’s personal assets.
For example, if you operated a sole proprietorship and were sued, you could lose personal assets to cover legal judgements or claims. With an LLC, lawsuits and claims remain at the company level, shielding your personal assets.
Tax flexibility
LLCs provide more tax flexibility than a standard corporation. LLCs are pass-through entities, meaning profits and losses pass through to the owners’ personal tax returns. The business itself does not pay income taxes. Rather, the owners report profits and losses on their individual returns.
LLCs allow you to choose how your business is taxed. By default, most LLCs are taxed as partnerships. With partnership tax treatment, income passes through and is taxed at the personal level rather than the business level. Some LLCs can choose S-corp status and take advantage of some tax savings.
Avoiding double taxation
Unlike C-corps, LLCs help avoid double taxation. C-corps are taxed at both the corporate and shareholder level. The business pays income tax on net earnings. Shareholders also pay personal income tax when dividends are distributed. This results in income being taxed twice – before dividends are paid out and again on the personal returns of shareholders.
With an LLC taxed as a partnership or S-corp, earnings are only taxed once on the owners’ personal tax returns. This avoids the double tax issue that C-corps face.
Writing off expenses
LLCs also provide advantages when it comes to writing off expenses. LLC owners can utilize business deductions and write-offs to reduce their taxable income similar to a sole proprietorship. Eligible expenses like office supplies, mileage, education costs, insurance, and other ordinary business expenses can be deducted.
Less paperwork and formality
Forming an LLC is generally less complex than forming a corporation. Less paperwork is required and there are fewer formal processes. Corporations require regular shareholder meetings, board of director meetings, votes, and extensive record keeping. Most LLCs have greater flexibility in management structure and require less formality.
LLCs are also easier to maintain year-to-year than corporations. You don’t need to file a separate tax return for the LLC. Profits/losses flow through to your personal tax return. Annual fees and paperwork are reduced thanks to the pass-through tax structure.
Increased credibility
Forming an LLC can boost your credibility with customers and vendors. It helps show you are running a legitimate business. The formal structure also provides some separation from your personal identity. Customers often prefer to work with an LLC over a sole proprietorship or general partnership.
Easier to raise capital
For some small businesses, raising capital is easier when organized as an LLC rather than a sole proprietorship or general partnership. The limited liability protection gives investors more confidence. An LLC structure also allows for greater options in dividing ownership stakes, issuing shares, and structuring investor agreements.
Flexibility in management and ownership
LLCs allow for a flexible management and ownership structure. Member-managed LLCs give members direct control, similar to a partnership. Manager-managed LLCs delegate control to appointed managers, like in a corporation. LLCs also allow for customized division of profits/losses and flexible ownership arrangements like owning percentages, units, or shares in the company.
Disadvantages of an LLC
While LLCs provide many advantages, some downsides exist as well:
- Higher start-up costs – Forming an LLC typically costs more upfront than a sole proprietorship or partnership. You often need to pay filing fees, lawyer fees, and establish an operating agreement.
- More complicated taxes – LLC taxes can become complicated depending on ownership structure, number of members, and income sources.
- Self-employment taxes – LLC owners pay self-employment taxes on their share of profits which can be higher than corporate taxes.
- Less perpetual existence – If a member leaves an LLC, it can dissolve the LLC if the operating agreement doesn’t plan for any changes in membership.
Is an LLC right for you?
Forming an LLC makes the most sense for established businesses with multiple owners, those wanting liability protection, and businesses operating in medium to higher risk industries. Service companies and real estate investors often find LLCs beneficial. LLCs may be excessive for low-risk businesses or sole owners unlikely to face lawsuits.
Some key questions to consider when deciding if an LLC is right for your business:
- How much personal liability risk does your business face?
- How many owners/members will be involved?
- What are your profit/loss distribution preferences?
- How much capital might you need to raise?
- What are your income and planned distributions?
- How complex will your ownership and organizational structure be?
- What are your tax situation and planning priorities?
Every business has unique needs and priorities. Evaluating these factors can help determine if forming an LLC is your best option or if another business structure like a partnership or sole proprietorship may fit your situation better.
Steps for starting an LLC
If starting an LLC seems like the right choice, follow these main steps to get your LLC up and running:
- Choose a business name – Select an official name for your LLC that complies with your state’s naming requirements.
- File formation documents – Submit an Articles of Organization form (or similar document depending on your state) to your Secretary of State’s office.
- Create an operating agreement – Draft an operating agreement detailing ownership percentages, member responsibilities, voting rights, profit/loss distribution, changes in membership, dissolution terms, etc.
- Obtain licenses and permits – Apply for any needed business licenses, sales tax permits, or other regulatory requirements for operating your LLC.
- Open a business bank account – Establish a business bank account in your LLC’s name to keep your business finances separate from your personal finances.
- Obtain an EIN – Apply for a free Employer Identification Number from the IRS to handle all tax-related filings for your LLC.
It’s also advisable to review your business needs with professionals to address any legal, tax, insurance, or compliance steps unique to your LLC. Many new LLC owners find getting help from lawyers, accountants, and management consultants worth the investment.
Conclusion
Starting an LLC provides a great combination of liability protection, tax flexibility, and organizational options for many small businesses. LLCs help limit risks, reduce taxes, raise capital, and establish credibility. Carefully weigh the pros and cons of an LLC to decide if it’s the right choice for your goals.
