When reading about or discussing business, you may have heard the term LLC mentioned quite a few times. You might be wondering what it is, if it's something you need to look into, and what the advantages are to having your own. Today, let's break down exactly what an LLC (limited liability company) is, the advantages to forming one and the disadvantages. One thing to note before we dive in, is that the exact rules for forming an LLC vary by state, so check with your local Secretary of State's office when considering starting one.
According to the U.S. Small Business Administration, "a limited liability company is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership." The Wall Street Journal simplifies this definition even further by stating that, "an LLC is similar to a partnership but offers the legal protections of personal assets that a corporation offers without the burdensome formalities, paperwork, and fees." To break it down even further, an LLC protects your assets without all of the red tape associated with corporations.
Owners of an LLC are referred to as members, and there can be numerous individuals, corporations, or other LLCs that make up these members. Upon formation, all new LLCs must file "articles of organization" - a short form that asks the name of the LLC, it's members, and their contact information - with their secretary of state's office. The filing fee for this step ranges from $30 to $200 depending on the state it's filed in. All LLCs must also file as a corporation, partnership, or sole proprietorship on tax returns.
Since state requirements are pretty easy to follow, you don't have to hire a lawyer to set up an LLC (consulting one would still be your best bet to stay on the safe side). Additionally, even though it is not required in many cases, many LLCs choose to draft an operating agreement that details the business arrangements, ownership percentages, roles, rights, and more to protect the LLC's structure if it's challenged in court or if someone leaves.
Advantages of an LLC
|LLCs exist separately from your personal assets.
This is a huge perk! Let's say you're a contractor that lost an exclusive prototype you were working on. As a sole proprietor, you can be sued personally. However, if you're part of an LLC, the business is responsible for all debts and liabilities, shielding your personal assets and separating them from those that belong to the business. This means that the company you were working for cannot come after your house, bank accounts and more for losing the prototype because these assets are not part of your business.
|LLCs protect what you have today and what you might have tomorrow.
Another benefit is that an LLC protects your assets for up to 22 years, so even if you don't have much today, it will protect what you could potentially earn later on. As long as your LLC is in good standing, your personal belongings most likely will be safe if you happen to be sued. As LawKick's blog puts it, "you'll only lose the money you put into the business and nothing else."
|LLCs will not be taxed as separate business entities.
Again, let's turn to the U.S. Small Business Administration to see how this works. "All profits and losses are "passed through" the business to each member of the LLC. LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would," states their website. Since it's not a separate tax entity, the business itself is not taxed by the federal government; however, some states do tax income on an LLC.
|LLCs have few corporate formalities.
It's not mandatory that an LLC holds regular meetings for the board of directors and shareholders, keeps written minutes of meetings, and files mandatory annual reports with the state. There's also no limit to the number of members an LLC can have. Members of an LLC can also deduct losses, receive tax flexibility, and can use the simple cash method of accounting.
Disadvantages of an LLC
|You must keep all things related to the LLC like business purchases, credit cards, and bank accounts separate from your personal finances.
While this may seem like a hassle, not separating your LLC's finances from your personal finances could put your LLC at risk and make tax time much more difficult. Also, since members of an LLC are considered to be self-employed, they must pay self-employment taxes for Medicare and Social Security. The entire net income of the LLC is subject to this tax.
|Depending on the state, when a member leaves, the LLC could be dissolved.
This leaves the remaining members responsible for tying up all lingering legal and business obligations in order to close the LLC. They can then decide if they want to start a new LLC or go their separate ways. However, provisions that are included in your operating agreement can help prolong the life of the LLC if someone decides to leave. Submitting "articles of amendment" or filing notifications of changes with your state when something changes, such as your company address, your LLC's official name, or a change in board members can also protect your LLC.
| LLCs can be confusing to other investors and companies.
Unlike corporations, LLCs generally do not have specific roles like director, manager or president. This could make it challenging for anyone who's looking to contact the person in charge of purchasing or the right contact to sign a specific contract. Plus, the rules of LLCs in one state vary from the rules regarding LLCs in other states, which can make doing business in multiple states tricky.
LLCs protect your personal assets, while remaining flexible and providing a variety of tax options. LLCs might not be the right fit for all businesses, but many choose to start one because it's the fastest and easiest way to protect your assets. If you do choose to start an LLC, consider speaking to a lawyer or accountant to make sure you understand all of the in's and out's that can vary from state to state.