The Truths about LLCs: What you need to know.

Is an LLC right for you? Here’s what you should know.   

When starting a business, the structure or business entity you choose will determine, among many things, how much you will pay in taxes, your ability to raise funds as well as  other legal requirements. Most startups opt for the LLC (Limited Liability Company) structure as it offers owners personal liability protection. This means, provided no fraud is detected, creditors cannot pursue the owners’ personal assets like their home, vehicle or bank account in the event the business goes into debt. 

What is an LLC?

An LLC (Limited Liability Company) is a legal business structure that business owners can use to protect their personal assets. It contains the elements of a general partnership and a corporation. LLCs can have one or more owners, called “members”. 

Why are LLCs so popular?Although the LLC format is relatively new (the first LLC company was formed in Wyoming in 1977), since then, thousands of startups have used this structure to form their new ventures for many reasons like these below.

8 Reasons why an LLCs is a good option

  1. Tax flexibility: An LLC can choose to be taxed as a sole proprietorship (a single-owned entity where the owner is legally responsible for debts), a partnership (a business association of two or more individuals) or a S corporation (an IRS classification where owners pay income tax and self-employment tax on a predetermined salary).
  2. LLCs don’t file corporate tax returns: An LLC doesn’t pay taxes directly, instead, the company’s revenue is passed through to the LLC’s owners who claim the business’ profits and losses on their personal tax returns. This is called “pass-through” taxation.
  3. Enhanced client perception: Having the letters LLC or phrase “Limited Liability Company”’ in your business name enhances the credibility of your business and makes it more appealing to banks and creditors for loans.
  4. Foreign businesses can start an LLC: You don’t need to be a U.S. resident to form an LLC, and can even operate an LLC in any state you choose without ever setting foot in America.
  5. Flexible management: You can choose how you want the LLC managed: by owners (called members) or managers, and how you want to split up the profits. LLCs may consist of a single owner or an unlimited number of members.
  6. Keep business income separate: When you’re starting out, it’s crucial to split up your personal and business finances. Doing this makes it easier when it comes to tax time.  LLC owners are able to open a business bank account and acquire business credit cards, which makes it easier than for sole proprietorships, to keep their finances separate and organized.
  7. Less maintenance: Unlike corporations, LLCs do not have to hold regular board meetings, shareholder meetings, record company minutes etc. This informal structure allows owners more flexibility in the way they run their business and make decisions.
  8. Growing your business When your business outgrows the LLC format, you can easily convert it to a bigger structure by simply transferring the assets to a corporation with the same owners as the LLC. This does however, require legal expertise and is best done with the assistance of an accountant and attorney.

Although the advantages of  the LLCs structure outweigh the disadvantages, there are still some factors you will want to keep in mind.

What are the disadvantages of LLCs?

  1. Costs. LLCs generally pay more filing fees compared to sole proprietorships and some states require LLCs to pay yearly renewal fees. Transfer of ownership may be harder and LLC than with a corporation. That’s because, in a corporation, each owner (called a shareholder), has an equal percentage of ownership. LLCs however, have no limit on the number of members, which means the ownership of members can be hugely disproportionate. 
  2. Taxation of profits
    Because LLCs are pass-through entities, all members are responsible for paying taxes on their share of income. This means as long as the LLC shows a profit, each member is taxed according to his share of what profit is earned, irrespective whether the profit is given to them or reinvested.
  3. Different state rules: The rules regarding LLCs vary from state to state. If you decide to, for example, start doing business in various states, you will have to abide with the compliance requirements for each of those states you’re operating in. In some instances it may be necessary to form subsidiary entities to operate in other states. Corporations and other business structures do not pose this problem.
  4. Self-Employment Taxes Members of an LLC who are actively involved in running the business are considered self-employed, which means they  will be subject to a 15.3% self-employment tax.  In addition, members of an LLC cannot pay themselves salaries. This removes any incentives for working members of an LLC to limit their distribution of profits and reinvest their shares of the profits into the business.
  5. Attracting investors is difficult. Investors are hesitant to become a member of an LLC that is taxed as a partnership, because as a partner, they’ll be taxed on the business even when no profit is distributed to them personally. For this reason many investors prefer a C-Corp, where shareholders are not taxed on a business’ profits unless profits are distributed.
  6. Fewer options to raise funds
    In a corporation, you can issue stock in exchange for funding. Because LLCs cannot issue stock, you will not be able to sell shares of your company.
  7. Maintaining the corporate veil
    LLCs are protected under the Corporate Veil, which means owners aren’t personally liable for the company’s debts and other obligations. However, this protection isn’t guaranteed and there are things a company can do to lose this benefit. The most common ways your corporate veil may be pierced are when:

    1. A court rules that the LLC is not a separate entity from you as an individual. For example, you pay personal bills from your business’ checking account. This makes it crucial that you separate your personal income and business income, and only use your business checking account and credit card for company business. Also, remember to sign all contracts in your company’s name and not your own.
    2. The LLC’s actions were fraudulent or wrongful. For example, entering into a business deal or borrowing and losing money, knowing that your business would not be able to repay the debts.
    3. The LLC was found to be non-compliant with tax laws.

Conclusion

Forming an LLC offers significant protection and benefits that are worth considering. That said, we encourage you to learn more about the LLC formation before deciding whether it is the right fit for your company.

Posted in: Personal Finance

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