What Is an LLC?
When looking to start a business or protect investments you have several options in the type of entity you can form. As with anything, there are advantages and disadvantages to limited liability companies. Limited Liability Company is one of the modern business structures. Its special feature is the unique hybrid nature showing protection of corporations and pass-through taxation of partnerships or sole proprietorships. The wide range of customization options and significant advantages make an LLC a great solution for aspiring entrepreneurs in various industries. By choosing an LLC, you can create one of the two types of businesses:
- Single-member LLC;
- Multi-member LLC.
Unlike a partnership or sole proprietorship, an LLC acts as a separate legal entity. The basis for the official registration of the company is the approval of formation documents by the Secretary of State. There is a state fee for the application processing, the cost of which depends on the state and ranges from $40 to $500.
The creation of an LLC allows you to conduct business without fear for the safety of your personal property. Unlike a sole proprietorship or partnership, an LLC enters into transactions on its own behalf and is responsible for its debts and obligations. If a business is sued, creditors’ claims will be limited to the firm’s assets, regardless of its financial status. Personal property of the owners, like savings, real estate, or cars, will be safe.
When you plan to launch an LLC, you should keep in mind that a court may deprive a business owner of limited liability protection. The primary reason for such a decision is the violations committed. For example, mixing personal and corporate assets or fraud.
Ease of establishment
As we are talking about a formal business, opening an LLC and corporation requires you to file formation documents. However, there are far fewer regulatory requirements for the LLC’s ownership and internal management structure. You do not need to create a board of directors or any other bodies. In addition, the legislation allows the LLC incorporation with one or more participants, without limiting the maximum number of them.
An LLC is a pretty simple business model, so you don’t have to hire a lawyer to draw up the papers. In most states, you can prepare the company documents yourself by taking just a few minutes.
Moreover, starting an LLC is usually cheaper than setting up a corporation, which makes this option especially attractive to startups.
While the corporation has to hold regular board meetings, as well as take meeting minutes, the range of LLC responsibilities is much narrower. What one should remember is to file reports to the state in a timely manner to keep the state databases up-to-date. Each LLC is required to provide an annual report regularly, a deadline for which is every one or two years, depending on state law.
Furthermore, there is a penalty for failure to pay taxes, which are determined by the industry and location of an LLC.
Although the amount of paperwork and fees involved with an LLC is higher than that of a sole proprietorship or partnership, maintaining it is easier than a corporation.
Benefits and tax deductions
Maintaining the smooth running of a company requires a certain financial outlay. If you are an active participant of your company, ensuring its normal functioning, you may qualify for certain perks. The law allows you to deduct a part of business losses from the regular income of the company owner. This is a benefit not available to C-corporation shareholders.
Free choice of tax regime
Like a partnership or sole proprietorship, the IRS treats an LLC as a “pass-through” tax unit by default. Under this method of taxation, the obligation to report the business profits and expenses falls on the entity’s owners. At the federal level, the company neither files a separate tax return nor pays taxes on its own behalf. Most states share such an approach.
Nonetheless, LLC members may switch to corporate taxation. This tax treatment is available as a C-corporation or an S-corporation. Due to the “double” taxation, the C-corporation type does not work for all companies. In this case, the income of an LLC is taxed both at the corporate level and when distributed among the owners. The choice of S-corporation, in turn, leads to significant restrictions for the organization, which also limits its operations.
Some states allow LLC members to stay anonymous by listing managers’ names and addresses on their formation documents instead of their own.
You can also avoid making the LLC’s mailing address public by hiring a professional registered agent.
- Startup costs.
As an LLC represents a formal business entity, state registration is an integral step in its creation. You are required to file formation documents, as well as pay a mandatory fee, the amount of which depends on the state. Although the cost of opening an LLC is lower compared to a corporation, it is still higher than the cost of establishing sole proprietorships or partnerships, which do not need to be registered.
- No limited liability for the owner of a single-member LLC.
The refusal by the courts to provide limited liability protection to the owner of a single-member LLC has been a tendency in recent years. Since such companies have no other participants requiring protection, many states have restricted the protection of single-owner assets. Today, only Nevada, Delaware, and Wyoming recognize single-member LLCs to have the same status as multi-member LLCs.
- Difficulties with attracting investment.
The only way to invest in an LLC is to become a member. This option does not suit all investors, therefore, many of them prefer to invest in the stock of corporations.
- Profit distribution.
An LLC has to distribute the income to its members or reinvest it in the company within one tax year. This can cause some hassle because most small business owners reinvest for several years.
- Industry-specific restrictions.
The LLC business structure fits not all types of enterprises. For example, you cannot use it to form a bank or an insurance company. Furthermore, many states impose additional restrictions for certain types of professions. Thus, to bring together lawyers or doctors, you have to open a Professional Limited Liability Company.
- Ongoing maintenance.
To maintain a company’s good reputation in the eyes of the state, the owner should oversee the LLC’s compliance requirements. You will probably have to pay a mandatory fee for processing annual or biennial reports, which can be quite expensive in some states. Plus, all formally incorporated companies are required to pay taxes regularly. The number, type, and amount of them depend on the state.
- Restrictions on additional privileges.
The LLC personnel are entitled to certain benefits, the most common of which are:
- Health insurance;
- Group insurance;
- Medical reimbursement plans;
- Parking, etc.
However, unlike C-corporation staff with similar benefits, from the IRS perspective, these LLC employee perks are their taxable income.
- Complex procedure for transferring ownership.
Shares of a corporation serve as proof of ownership of a company. At the same time, they are easy to sell or transfer. An LLC, on the other hand, is prohibited from issuing stock, so transferring ownership of a business can be time-consuming and expensive.
This problem is extremely relevant in the case of multi-member LLCs, as the decision to transfer rights has to be coordinated with all the participants.