Limited liability companies, or LLCs, present a unique opportunity for people looking to start their own business — but how do you know whether forming an LLC is the right move for your business venture? Take the first step by learning the potential benefits and downsides commonly associated with LLCs.
What Is an LLC?
A limited liability company is a flexible type of business structure that allows for many forms of organization and tax treatment for businesses. An LLC can be formed by one individual or can consist of any number of individuals, corporations, and even other LLCs.
Individuals or entities who own an LLC are referred to as members, and they have several options for how they want to organize themselves. Per the IRS, multi-member LLCs may be treated like a corporation, a partnership, or as an entity separate from its owner for single-member LLCs.
Brief History of the LLC Structure
The LLC is a relatively new business structure considering the long history of business ventures — the idea originated when smaller businesses sought to tap into the tax and liability advantages gained by organizing as a corporation while still maintaining the flexibility and freedom offered by a partnership.
The LLC emerged in the 1970s, when the first limited liability company statute was passed in Wyoming. Since then, LLC statutes have been created in each state, giving business owners the freedom to operate wherever they want.
Difference From Other Business Structures
The key difference between an LLC and other business structures is its flexibility. Those entering an LLC together can set up the ground rules for their relationship, similar to a partnership, while maintaining the benefits once reserved for larger, more rigid corporate entities.
What Are the Key Features of an LLC?
It’s helpful to understand the features that define an LLC’s utility to small business owners. There are four key features that business owners are generally drawn to when thinking about LLC formation.
Limited Liability Protection
Under traditional business law, business owners could once be held personally liable for business debts. In the global economy, life can be highly unpredictable — making it tricky for any one individual to be held accountable for liability incurred through their business.
Traditionally, the solution was to form a corporation that would operate as a separate entity from the business owners themselves. However, corporation statutes have rigid requirements imposed that are often cumbersome to smaller business owners or sole proprietors looking to curb personal liability.
Because of this, the LLC was formed in part to provide the benefits of limited liability to its members. As a member of an LLC, you’re only liable for the investment you make in the company.
Taylor Fike, Partner at Fike Advisors and Expert Contributor for Mosey states: “Keep in mind, while an LLC is a great way to limit personal financial liability, it is not a shield from illegal activity. If a member of an LLC commits fraud, or any other crime, they can still be prosecuted to the full extent of the law. The limited liability only pertains to your personal assets not invested in the company.”
Flexible Tax Options
An LLC also provides several tax options. For most LLCs, members can elect to pay taxes either as a sole proprietorship or partnership, as a C-corporation or S-corporation, or as a disregarded LLC. This flexibility allows LLC members to choose the income tax treatment that best fits their individual needs. Members may also need to pay self-employment taxes and indicate this on their personal income tax returns.
Fike also notes that it’s important to know that LLCs still pay taxes. There are some trends on social media that are falsely encouraging business owners to “open an LLC so you don’t have to pay taxes.” If your business generates a profit, there will be taxes to pay. Choosing a different tax class with the flexibility of an LLC can be beneficial with some expert planning. Seeking the help of a CPA is a great way to maximize tax savings when operating an LLC.
Members of an LLC can enjoy plenty of freedom when it comes to organizing their management structure. Typically, LLCs can be operated as a partnership where members cooperate jointly in running the business (known as member-managed). Or, members can elect to place certain responsibilities in the hands of select members (known as manager-managed).
In either case, the flexibility of the LLC is showcased. This is different from the rigid requirements that corporations or other legal entities typically face, where officers and boards of directors often need to be appointed and carefully maintained to remain in business.
Fewer State-Imposed Requirements
Because LLCs blend the typical understanding of both partnerships and bigger corporations, states often impose fewer requirements on LLCs than on corporations. Since there are fewer limits to the number of members an LLC can have, it’s easier to bring new participants into a business venture, paving the way for more flexible day-to-day operations.
What Are the Benefits of an LLC?
An LLC offers many benefits to its members beyond the organizational structure of the company, extending even to the often unpredictable future of a business.
Members of LLCs benefit from significant protection of their personal assets since the LLC is regarded as a separate entity from its members. Because of this, debts incurred by the company can typically only be recovered against the company itself — in other words, in most cases, members’ personal assets are shielded from any liability incurred by the company itself. If the LLC only has one member, it’s considered a disregarded entity during taxing, unless elected to be classified differently.
Tax Flexibility and Benefits
While LLC members are said to hold their business at arm’s length for liability purposes, the same is not necessarily true in every case for tax purposes. For some businesses, organizing as an LLC allows the members to pass the profits or losses of a business on to their personal tax returns (known as pass-through taxation), avoiding the possibility of “double taxation” at both the business entity and personal levels.
In other cases, owners of an LLC can choose to be taxed as a corporation, depending on their preferences. The LLC provides an enviable level of flexibility in this area since every business will have different needs when it comes to tax treatment.
For small business owners, credibility is often a key component in appealing to investors. LLCs are an increasingly common business structure that many people associate with savvy business operations, meaning that the “LLC” tag behind the name of the company will often convey competence and credibility.
What Are Some Key Considerations Before Forming an LLC?
Even with the benefits of organizing as an LLC, this business structure is not always the perfect fit for every company’s needs. Here are a few points to keep in mind before deciding.
Tracking State Regulations With Mosey
Because the LLC is a relatively new business structure, each state has a different LLC statute. As a result, multi-state companies that organize as an LLC, as well as companies with remote workers in several states, need to keep tabs on different state laws. This can be hard to keep up with for smaller businesses. For instance, states differ over the specifics of LLC operating agreements as well as the frequency of filing annual reports.
On top of the evolving LLC laws around the country, state requirements for LLCs also vary, making compliance tools key. Mosey is a platform that combines automation and expertise with tools to help companies manage ongoing business compliance requirements at the state and local level, streamline the process of entering a new state, and even keep tabs on upcoming legislation affecting the business.
Although LLCs are generally preferable to sole proprietorships or general partnerships due to their increased protections for members, most states have LLC filing fees and annual fees associated with forming and maintaining an LLC.
This tradeoff is often minimal, as the fees are much lower than the costs of organizing as a business. Each business owner has to assess their needs to make that call.
Limitations on Raising Capital
Because LLCs use a more flexible business structure than corporations, they typically can’t offer shares to potential investors. This could be a limitation in some cases, depending on whether the business model relies heavily on venture capital to start the company.
Generally, LLCs will need to look for investments in smaller banks, take out loans, or possibly offer investors equity in their company. This can be an important consideration depending on the business model in place.
The Bottom Line
LLCs could represent a new frontier for small businesses and startups because of their liability protections, tax benefits, and overall flexibility. LLCs also give business owners the credibility they need to attract interest without weighing the company down with strict regulations.
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