A Limited Liability Company or LLC is a business entity type that combines the tax benefits of a partnership with the personal liability protection of a corporation. Forming an LLC can help you separate yourself from your business, thereby protecting your personal assets from the company's debts, as well as, judgments against the company.
An LLC is a flexible business format that works very well for owners who want limited liability and flow-through taxation, but can also be used like a corporation. What follows is an examination of the main reasons why you may want to start an LLC for your business operations.
Limited Personal Liability
An LLC is an excellent way to create a barrier between your personal assets and your company's debts. It can also safeguard your personal assets if someone wins a lawsuit or obtains a judgment against your company. This is protection that is not provided by a sole proprietorship or general partnership.
It is, however, extremely important that you operate and treat your LLC as a separate entity or risk losing the liability protection the entity can provide. This can happen to you if, for example, commingle your personal and business finances, or fail to use the full name of the entity in your business dealings.
Another important feature of a limited liability company is the flexibility to select the type of taxation that will apply. The owners of an LLC can elect to have the entity taxed as:
A Sole Proprietorship - if you're a single-member LLC, you can elect to be treated as a sole proprietorship, which is a disregarded entity for tax purposes. In this case, income from your LLC will flow through directly to you to be reported on your individual tax return.
A Partnership - in addition to pass-through taxation, certain debts can be treated as a basis to allow you to deduct certain losses to a greater degree than as an s-corporation shareholder.
A Corporation - as the LLC's owner, you can also elect to be treated as an s-corporation or c-corporation for tax purposes. You will then enjoy the tax benefits of a partnership and the protection of a corporation, but without the various requirements and formalities that come with incorporating.
Another feature of a limited liability company is that you can offer as many classes and types of equity interests in your LLC as you want. You can provide for the various classes of ownership in your LLC’s operating agreement or other member agreement.
Furthermore, these classes can be amended and changed in accordance with the rules for doing so as established in the operating agreement and as limited by state law. Of course, if you elect to have your LLC taxed as a corporation, limitations will apply the same as if it were structured as a corporation.
Your LLC can be member-managed or manager-managed. For a smaller business with only a few owners who actively manage the business, a member-managed LLC will offer simplicity. However, for companies with members who will not be involved in active management of the LLC, a manager-managed entity may be a better option.
Other Advantages of an LLC
Along with asset protection and tax flexibility, an LLC business structure has a number of other advantages, including:
- No residency requirements - ownership of an LLC is not restricted to U.S. citizens and permanent residents.
- Less record keeping - with an LLC, there are no annual meetings or minute books required.
An LLC combines the asset protection of a corporate structure with the simplicity of a partnership structure, making it one of the most popular business entity structures for small businesses. There are, however, a few disadvantages to an LLC as a business entity, for example:
- An LLC does not have the ability to utilize a technique called corporate income splitting nor the ability to issue stock to raise capital.
- An LLC is subject to employment tax unless it is taxed as a corporation.
- An LLC is more expensive to operate than a sole proprietorship or general partnership.
- While LLCs are recognized in all 50 states, the laws governing LLCs vary from one jurisdiction to another. For instance, while some states recognize the flow-through tax treatment of an LLC and tax it as a separate entity, others do not. Thus, there is a lack of uniformity from state to state.
Nevertheless, for many small business owners, the benefits of an LLC structure far outweigh the drawbacks, making it the most popular choice for small business owners across the United States. To determine if an LLC is the right business entity structure for you and your business, seek the advice and guidance of an experienced business law attorney.