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What is an LLC?
An LLC, or Limited Liability Company, is one type of legal entity that can be formed to operate a business. Forming an LLC provides a business owner with asset protection just like a corporation because it separates the business entity from the owners. The tax structure of an LLC, however, is closer to that of a sole proprietorship because profits and losses are reported on an owner’s personal tax return.
An LLC is just one way that a business owner can organize their business. Other options include:
- Sole Proprietorship: In sole proprietorships , one person owns the business and does not have the benefit of any liability protection.
- General Partnerships: A general partnership is like a sole proprietorship in that there is no protection for liability, but in this structure, two or more people own the business.
- Limited Partnerships: In limited partnerships structure, general partners operate the business and have personal liability and limited partners while they contribute to the business, do not have personal liability.
- Corporation: A corporation ( S Corp , C-Corp , etc.) is owned by shareholders or stockholders and provides the most liability protection for owners. This business structure can be complicated because the shareholders must elect a board of directors to make business decisions and run the day-to-day operations of the business.
An LLC is a great option for small businesses just starting out because like a sole proprietorship, it is easier and less expensive to form than a corporation, but it provides protections for the owner just as a corporation would.
For a more in-depth explanation of LLCs, click here.
What is an LLC Used For?
If you are starting your own business, there are a lot of things to take into consideration when choosing the form of a business entity like taxes, liability protection, ownership structure, management, and expenses.
An LLC will allow a business owner to limit their personal liability for business debts, raise capital from investors, and benefit from many tax advantages.
Although we generally associate an LLC with small businesses like the local coffee shop, even large multi-million-dollar business entities can be formed as an LLC. Some famous businesses that have an entity that is an LLC are:
- Exxon Mobile
- General Electric
Click here for more information about LLCs directly from the IRS website.
Benefits and Downsides to LLCs
An LLC will provide a business owner with both benefits and downsides. It is important to weigh these options when deciding which business formation is right for you.
Benefits of an LLC
- Limiting Personal Liability for Business Debts: An LLC protects an owner from certain liabilities, one of these is liability for business debts. An LLC separates the owner from the business so in the event of a lawsuit or claim of a creditor, only business assets are at risk to be claimed to satisfy a business debt. An owner’s personal property and assets like a house or personal bank account are protected. This is generally the most important reason a business owner chooses an LLC over a sole proprietorship.
- Ability to Raise Capital from Investors: The owner of an LLC has the option to bring in investors who can contribute additional capital, property, or even services to the business.
- Tax Advantages: When operating an LLC, the owner will not have to file a separate tax return for the business. LLCs are often called a “ pass through entity ” because profits and losses from the business pass through the business to the owner’s personal tax return. One benefit of this tax structure is avoiding the “double tax” that most corporations are subject to where income is taxed first under the corporation and then again at the individual level.
- Simplicity and Flexibility: An LLC is one of the most simple and easy to form legal entity. It is less expensive and easier to maintain because it does not require directors and shareholders like a corporation. An LLC also provides endless flexibility for a business owner. There are no limits on the number of owners allowed so an owner or owners can choose how to run and manage their business. An LLC with more than one owner can also choose how they want to be taxed whether it be like a sole proprietorship or like a corporation. Opting for an LLC to be taxed like a corporation has its own unique business benefits.
- Credibility : Forming an LLC makes your business its own legal business entity. This makes your business look and feel more professional and credible to consumers.
Image via Pexels by Christina
Disadvantages of an LLC
Even though the business formation of an LLC provides the owner with great liability protections, there are limits to this protection. An LLC owner will still be personally liable in a lawsuit for their own negligence, even if the claim is related to the business.
An LLC also does not protect an owner from losses due to fires, floods, lawsuits, or an economic downtown. Therefore, it is important to carry business insurance on your LLC.
Another disadvantage of an LLC is the lack of investment opportunities. If an owner is seeking to bring in outside investors, there are no stock options available in an LLC like there are in a corporation. Normally, an investor will trade funding for a share in the business stock. Without the available stock, there is less incentive for an investor to invest in an LLC.
Who Should Form an LLC?
If you are debating whether an LLC is the right business formation for you, ask yourself these two questions: “Do I have co-owners or employees?” and “Does my business have significant risks?”. If you answered yes to either of these questions, an LLC would benefit your business.
If you have a co-owner or employees, your business could potentially be sued for the actions of these people. Without the protection of an LLC, the business owner’s personal assets could be at risk in this lawsuit.
Opening any business is risky, however some businesses pose more of a risk than others. Many property rental companies choose to use an LLC because each rental property will be its own entity. Failure or issues with one property will not put the other properties in jeopardy.
Click here to read about articles of organization , which are required to be filed when starting an LLC.
How Are LLCs Taxed?
Tax advantages are one of the main reasons a business owner will opt for an LLC over a corporation. An LLC is taxed by what is called “pass-through taxation”. This means that the profits and losses of the business pass through the business and are filed with the owner’s personal tax return. The profits and losses will be taxed based on personal tax rates.
This tax structure is much like that of a sole proprietorship. The LLC owner will report their businesses profits, losses, and deductions to the IRS using a Schedule C form filed with their personal tax return. If there is more than one owner, each owner will file profit and losses with their own personal tax return.
To read more about pass through entities, check out this article.
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