When you’re setting up a new business, one of the first things you need to establish is its structure. For instance, you may choose to form a sole proprietorship, a partnership, or a regular corporation (also known as a C-Corporation).
However, one of the most popular business structures is the limited liability company (LLC).
So, what does LLC mean? Read on to learn what an LLC is and the advantages and disadvantages of having one.
What Is an LLC?
A limited liability company (LLC) is a business structure that offers its owners protection of their personal assets. The owners’ private wealth (like their homes, cars, and investment accounts) won’t be at risk if the company goes bankrupt or is sued.
It’s helpful to think about limited liability companies as having qualities of both corporations and partnerships. LLCs are a great option for small businesses that want to safeguard personal assets by forming a legal entity, but don’t want to pay corporate taxes. LLCs also have minimal requirements as to how they’re governed and maintained.
An LLC is owned by members and is formed by filing articles of organization with the state. Articles of organization are a fairly straightforward document that assigns the members, physical location, and registered agent of an LLC.
A Professional Limited Liability Company (PLLC) is a type of LLC that is available to licensed professionals providing a service in the same state.
LLCs are often confused with Limited Liability Partnerships (LLPs), a type of partnership, and Professional Limited Liability Companies (PLLCs). These alternative business structures are popular among licensed professionals like lawyers and architects who can’t form LLCs in certain states but want to limit their personal liability.
The structure of an LLC is very flexible — it’s up to the members to decide how voting, ownership, management (LLC member vs. manager-managed), and meetings will function and to describe these terms in an LLC operating agreement. Though not required by most states, an operating agreement is an important measure in ensuring the success of an LLC.
Benefits of an LLC: Advantages and Disadvantages
The simple, flexible structure of an LLC is ideal for small businesses. But what are the benefits of an LLC exactly?
Limited Personal Liability
This is the key advantage for LLC owners (also known as members). An LLC is legally separate from its owners and responsible for its debts and obligations. This means that, although you can lose any investment you’ve made in your company, your personal assets are protected if the business gets into legal trouble.
You might be thinking that corporations also offer limited personal liability. They do, but they’re also bound by specific requirements that may not be appropriate for a small business.
One of the advantages of an LLC is that you’re not obliged to hold annual shareholder meetings. Furthermore, you’re not required to keep extensive records like a corporation. In fact, many states don’t even require LLCs to file annual reports.
Tax Advantages of an LLC
The biggest benefit of an LLC is arguably its tax structure. No specific federal tax classification is attached to an LLC, but it can use the tax status of a sole proprietorship, a partnership, an S-corporation, or a C-corporation. This flexibility allows you to mitigate the taxes you must pay annually.
Another advantage of an LLC is the flexibility it offers. With an LLC, taxes can pass through the business and be paid on the owner’s personal tax return instead. An LLC is not obligated to have any specific number or type of members either.
With an LLC, you’re not required to have a board of directors or annual shareholder meetings, like a corporation. No formal structure is needed, and owners have more flexibility in the way they run their businesses and make decisions.
Profit Distribution Options
LLCs have great freedom in how they distribute profit to their owners. You don’t have to distribute profit equally, nor do you have to distribute it according to the ownership share of each member. For example, if three members own an LLC equally, they can still agree that one party should receive a higher percentage of the profit if, for instance, that person invested more during the initial formation of the business.
Disadvantages of an LLC
There are also drawbacks to setting up an LLC. Disadvantages of an LLC include the following:
Certain states, such as California, charge additional fees for operating an LLC — like an annual franchise tax.
When the LLC has not made an s-corporation election for tax treatment purposes, if income is split between LLC members and the business, all income may be liable for payroll or self-employment taxes. LLC taxes may be higher than corporation taxes if individual members are paying out-of-pocket for federal items such as Medicare and Social Security.
Some states may not allow certain professions, such as doctors or dentists, to operate using an LLC.
If you’re making an amendment to the LLC operating agreement, each member must give permission before membership interests are transferred. However, this could also be an advantage in some circumstances.