Choosing the right business entity can be tricky, but understanding what an LLC is can help you make the best choice.
- Limited liability companies, or LLCs, safeguard a business owner’s private assets in the event of litigation.
- An LLC may be taxed as a partnership, S corporation, or sole proprietorship.
- In contrast to an S-corp, which is restricted to 100 shareholders, an LLC can have an unlimited number of members.
- This article is for company owners who wish to determine whether an LLC is the best legal form for their new venture.
When a startup selects a business legal form, a limited liability corporation (LLC) is a common choice. The flexibility of an LLC allows you to choose your tax treatment and the maximum number of permitted shareholders. The most alluring feature of an LLC, though, is its capacity to reduce personal responsibility in the event that your company is sued or declares bankruptcy. Continue reading to discover more about this company structure, its pros and drawbacks, and how to launch one.
What is an LLC?
An LLC is a type of legal entity that combines elements of partnerships, corporations, and sole proprietorships.
Attorney Ryan Gordon stated that LLCs are simply another corporate form for the protection of business owners.
In general, LLCs are quite beneficial for business owners. They offer the same liability protection as companies without necessitating corporate recordkeeping, board meetings, or other time-consuming activities.
An LLC can be a company of any size, which increases its adaptability. A common and adaptable business legal form is an LLC, particularly for new and small businesses.
What are the benefits of an LLC?
For companies and owners, an LLC offers a number of advantages, including the following:
It protects owners’ assets.
The biggest advantage of an LLC is that it safeguards the assets of its shareholders in the event that the company runs into legal problems. Suppose a lawsuit is filed against your company. If your company is established up as an LLC, any judgements rendered against the company won’t affect your personal assets. You as the business owner won’t be required to use personal funds to satisfy the judgement if your company is unable to do so.
It offers management flexibility.
Flexibility in the organizational structure of the company’s management team is another important advantage. An LLC can either be managed by members, in which case the owners take care of day-to-day tasks, or by managers, in which case the owners hire an outsider to take care of the firm’ daily operations. An LLC allows you to see how earnings are shared among the owners in accordance with the operating agreement; it does not place a cap on the number of owners a firm may have. According to Paolo De Jesus Jr., co-managing partner at Romano Law, “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.”
It doesn’t require much paperwork.
An LLC is also a good option to think about if you dislike paperwork because it involves a lot less paperwork and administrative processes than other business formats.
What are the disadvantages of an LLC?
The drawbacks of an LLC pale in comparison to its advantages. When operating as a sole proprietor, becoming an LLC might occasionally be more expensive than remaining as such. It’s possible that you’ll have to pay franchise tax and yearly reporting expenses that wouldn’t be necessary for a single proprietorship. Additionally, if your LLC is a partnership, it could be more difficult to transfer ownership shares than it would be with a S company or C corporation.
Of course, if you form your LLC as a S company or C corporation, you may avoid the latter issue. Although doing so has the drawback of requiring you to file additional paperwork, depending on your financial status, this change may result in cheaper taxes. The additional documentation could be worthwhile in light of that.
How are LLCs taxed?
LLCs are referred to by the federal government as “disregarded entities.” When you select this specific company structure, the IRS taxes you as a corporation (either as a S corporation or a C corporation, depending on what you choose), a partnership (if you have more than one person), or a sole proprietorship (if you are a single-member LLC). After making this decision, the company determines taxes for the IRS based on those tax regulations and then creates an LLC return for the state where they conduct business.
The advantage of this taxation system is that, unless the LLC is a C-corp, it is not required to pay separate federal taxes. This is due to the fact that each LLC owner receives a share of the company’s revenues and losses, which they subsequently include in their personal income tax returns. By using a “flow-through” structure, businesses are spared the double taxation that occurs when an individual owner of the firm pays personal income tax on business profits.
However, company owners may be in a higher tax category and must pay self-employment taxes. By choosing to be taxed as an S-corp in certain circumstances, they could be able to save money.
According to Gordon, “it is actually conceivable for an LLC to also be an S-corp for tax reasons.” “Partnership taxation is really the default categorization of an LLC for tax purposes, while LLCs may alternatively be taxed as partnerships.”
What is the difference between an LLC, S-corp and partnership?
Many new business owners inquire about the distinctions between an LLC, a S corporation, and a partnership when deciding on their legal form.
Let’s start by clearing out the main cause of misunderstanding, which is when people use these phrases to refer to a legal entity’s structure when they’re actually discussing its taxation. A tax categorization is an S-corporation.
According to Heather Harmon Kennedy, proprietor of Harmon Kennedy Law, there is no such thing as an “LLC tax.” Therefore, even though an LLC may be your chosen entity form, you may be subject to S-crop taxation or C-crop income taxation.
The IRS sees your LLC as a sole proprietorship if it simply has you as a member. If there are many members, the LLC will be taxed as a partnership. Then, if your individual tax position permits, you may decide to tax the LLC as an S-corp.
With an S-crop, business owners may lessen their personal tax burden since they are paid a salary and have their payroll taxes taken care of by the company, which eliminates the need for them to pay self-employment taxes. S-corps, however, are subject to extra limitations. For example, non-U.S. citizens are not allowed to own shares in S-corps, but they are allowed in LLCs.
According to well-known trademark attorney Xavier Morales, an LLC is more adaptable and typically less constrictive than an S-corp. For instance, although an S-corp can have up to 100 shareholders or owners, an LLC can have an infinite number of members.
Do LLC laws vary by state?
The sorts of businesses that can be founded via an LLC are limited in several states. For instance, several states don’t allow companies in the financial services sector to set up an LLC.
There are tax considerations to be made, especially given the variation in state tax regulations, according to Susan Henderson, senior tax manager at California-based Hudson Henderson & Company Inc.
According to Henderson, “for some businesses, an LLC makes sense, as it allows the operation of a business with many investors and, potentially, the flexibility to distribute income however they deem appropriate from a year-to-year basis.” Of course, this assumes they have adopted the partnership tax treatment for the IRS. This flexibility might also apply to determining which members are subject to the Social Security income tax and which are not. The tax regulations in your state must be understood in order to evaluate whether this is advantageous for you because state laws on LLCs vary substantially.
How do you start an LLC?
Here is what has to be done to be set up for business owners that want to use an LLC. Although your state may have different standards, the following general guidelines are applicable no matter where you live.
1. Choose an available name for your business.
You may check to see whether the name you desire is still available in many states before deciding on a business name because you can’t use one that has already been registered. Notably, you must register a “doing business as” (DBA) name if the name of your company that customers and clients perceive is different from the LLC name that the government sees.
De Jesus advised being creative and distinctive while selecting a name to prevent confusion and potential trademark infringement charges. “You might wish to reserve the name you have chosen if it is available but you are not yet prepared to file the LLC forms. This will help ensure that it is not already taken when you file. The reserve period’s duration varies from state to state.
2. Choose a registered agent.
A registered agent is a person or business in the state where you are forming your LLC who receives your formal paperwork on its behalf. A registered agent essentially acts as a middleman who communicates with you. Most states consider this to be necessary.
3. Prepare the LLC operating agreement.
De Jesus advises creating one even if it might not be necessary in some jurisdictions since it’s crucial to have a plan for how your LLC will operate.
The operating agreement contains the information below:
- Business organization
- Board of managers
- Voting requirements
- Restrictions on transferring and selling shares
- Division of company profits and losses
- Dissolution of the company, if needed
4. File articles of organization with the state.
Articles of incorporation must be submitted to the secretary of state’s office in order to create an LLC. You’ll need the name, address, and purpose of your LLC to complete this form. The filing fee varies by state, and the articles of organization may go by other names, such as the certificate of formation. To organize your LLC, you might enlist the assistance of a nearby accounting company or lawyer.
LLCs are often the right choice
Creating an LLC is a reasonably simple process, and it may be quite beneficial in the event that your company is ever sued. Depending on how you choose to pursue federal corporation status or if you do at all, it may also have a favourable effect on your taxes. Look out the LLC rules in your state, get professional advice, and before long you’ll have the legal protection that every company need.