You might already have a lot on your mind if you are planning to start a new company.
What if there was a considerably simple way of achieving these goals?
Creating an LLC is an excellent way to protect your personal assets and also experience tax benefits.
This versatile business structure keeps the corporate formalities and paperwork at a minimum while offering a host of benefits.
Irrespective of whether you are a sole owner or have other partners, you can experience many valuable benefits.
- So, what are these benefits?
- How is an LLC better than other popular business structures?
- What are the different types of LLCs?
- Is LLC the right choice for you?
Let us discuss all of these questions to help you make the right decision.
What is an LLC?
An LLC or a Limited Liability Company is one of the most popular business structures. It combines the features and benefits of Sole Proprietorship or Partnership with those of a Corporation.
An LLC can have a single owner or multiple owners. The owners are members of the LLC.
- An LLC with a sole owner is single-member LLC (SMLLC).
- Multi-member LLC (MMLLC) is one that has multiple owners.
Advantages of LLC
Some of the essential benefits of LLC are as follows:
- Asset and Liability Protection
The personal assets of the owner/s are at risk in case of a Sole Proprietorship or Partnership. Their personal assets like car, home, bank accounts, etc. can be used for clearing unpaid debts or settlement if someone sues the company.
Things are not the same in case of LLCs. They offer personal asset protection. However, there are exceptions to the protection.
You create a separate entity when you create an LLC. You are not responsible on a personal level in case of unpaid company debts or court settlements. You don’t get the same protection with Sole Proprietorship or Partnership.
- Tax Saving
IRS considers LLCs as “pass-through” tax entities. This means that all the income, gains, losses, deductions, tax credits, etc. are “passed” through the owner/s. Reporting of all of these amounts will happen through the individual return of the owner/s.
Tax payment is as per their individual tax rate of the owner/s.
Active members of the LLC can also deduct operating loss against their regular income. Moreover, you will not be paying any unemployment insurance taxes on your salary as an LLC member.
But LLC members have to pay self-employment taxes based on their profits or remuneration from the company.
- Easy Business Transfer
The company owner has to individually transfer all the business documents for transferring or selling the business in a Sole Proprietorship. Selling your interest is a very time consuming and complicated process with Partnerships too.
You can transfer LLC to your next generation or any 3rd party without disrupting the business operations in any way.
Some other advantages of creating an LLC:
- No restrictions on the number of owners
- Easier to place ownership interests for beneficiaries in a living trust
- Flexibility in terms of raising capital
LLC vs Corporation, Partnership, and Sole Proprietor
There are several nuances between how all the different business structures function. We’ve only considered some of the factors that are most important for every new business owner in this comparison.
- Ease of Starting
As compared to other business structures, Sole Proprietorship is the easiest to start. Apart from the appropriate permits and licenses that your business needs, you don’t need any other formal action.
Sole Proprietorship is closely followed by Partnership in terms of the ease of starting the business. You need to file a number of organising documents with your state office in case of a Corporation or LLC.
But starting an LLC is generally easier as compared to a Corporation in most states.
- Maintenance and Management
A Sole Proprietorship and even a Partnership is the easiest option even in terms of maintenance and management. Unlike a Corporation, you don’t have to engage in any kind of formalities with regards to your business operation.
Ease of maintenance and management of LLC is somewhat in between Corporation and Sole Proprietorship. In most of the cases, LLCs do not require organizational or decisional formalities of a Corporation. But some state laws do ask for regular reports from LLCs too.
- Personal Liability Protection
This is the area where LLCs and Corporations are a better option. Your company is not seen as an entity separate from you if you have a Sole Proprietorship or Partnership.
This means that your personal assets are at risk with these structures in case of unpaid debt or settlement of the lawsuit.
With LLC or Corporation, you create a business entity separate from you. This keeps your personal assets protected. While LLCs and Corporation both protect your personal assets, LLCs are generally more beneficial.
They are easier to start as compared to Corporation and also easier to maintain. Even the scope of saving money in taxes is better in LLC than Corporation.
- Tax Treatment
Sole Proprietorship or Partnership owners have to report all their business expenses and income in their personal tax return. If you form a Corporation, you have to file separate tax for your company.
The tax treatment of LLCs is unique. They have the flexibility to choose between a Sole Proprietorship or Partnership based on the number of owners, or even a Corporation. The IRS does not consider LLCs as a taxing entity.
In short, LLC is one business structure that offers that benefits of Sole Proprietorship or Partnership along with those of a Corporation.
But there are also a few drawbacks of creating an LLC.
Disadvantages of LLC
Here are a few disadvantages of LLC, which you should know:
- Cost of Starting an LLC
An LLC is more expensive to start and operate as compared to Sole Proprietorship or Partnership. But it is still cheaper than starting and managing a Corporation.
- Limitations to Personal Asset Protection
The personal asset protection offered by an LLC is not absolute. There are a few limitations to it like
- Liabilities due to own wrongdoing
- Direct and personal injury to someone
- Unpaid payroll taxes
- Personally guaranteed debts
The owner/s has to pay self-employment taxes in LLCs that receive treatment of a Sole Proprietorship or Partnership for tax purposes. But if the LLC receives tax treatment of a Corporation, then there are no self-employment taxes.
Life of LLC
A multi-member LLC no longer exists if any of its members depart. Operating Agreement of the LLC is usually used for eliminating this problem.
Types of LLC
There are also different types of LLCs to help business owners select one that best suits their requirements. Some of the most popular ones are-
- Domestic LLC– If an LLC only operates only in the state of its creation, it can be a Domestic LLC.
- Foreign LLC- If a Domestic LLC has to register itself as a Foreign LLC if it wants to shift the operations to a different state or expand to another state.
- Professional LLC- LLCs involved in professional services like legal practices or accounting register themselves as a Professional LLC.
LLCs do not directly pay taxes to the IRS. They use the “pass-through” taxation system where all the profits, losses, tax credits, deductions, etc. are passed to the owner.
- Taxation of Single-Member LLC
The single owner of the company will pay taxes of the company on his/her Form 1040 in case if it is an SMLLC.
- Taxation of Multi-Member LLC
Each owner of the company pays taxes as per their share in the company in MMLLCs. First Form 1065 is used for filing an information return. The information return reports the gains, income, losses, credits, deductions, etc. of the LLC members.
Schedule K-1 is then filed to show the profit or loss share of every owner. Form 1040 of every owner shows the profit or loss of their LLC.
- Taxation of LLC Treated as Corporation
If the LLC can take advantage of lower tax rates, they can also elect tax treatment of a Corporation. The standard corporate tax rules will apply to each of its members in such cases.
Is LLC Right for Me?
LLC is an excellent option for the majority of small businesses. It offers a great combination of simplicity, flexibility, and personal asset protection. Unlike a Partnership or Sole Proprietorship, an LLC keeps your personal assets protected in most cases.
Unlike Corporations, LLCs are easier to create and maintain and are also protected from double taxation.
But even after knowing these benefits, you should avoid taking any quick decisions. You should first talk to an attorney with considerable Corporation and LLC experience. Next, talk to a CPA who thoroughly understands the tax differences between all the different business structures.
Based on your discussion with the attorney and CPA, you can decide whether or not you’d like to register as an LLC.