A limited liability company (LLC) is a business structure in the United States that merges the limited liability protection granted to a corporation, together with the flexibility and simplicity of a sole proprietorship or partnership. According to the Internal Revenue Service, an LLC is allowed by state statute thus, regulations may differ from state to state.
The Basics of Limited Liability Companies
LLC owners, called members, are shielded from personal liability in relation to business debts and obligations. This limited liability aspect safeguards the personal assets of the members. Similar to partnerships, LLCs are known for their pass-through taxation. As one of the tax benefits of an LLC, pass-through taxation grants members the ability to report their share of business profits and losses on their individual tax returns.
LLC ownership is not limited to individuals. Members may further be corporations, foreign entities, and even other LLCs. However, a few business types, such as banks and insurance companies, are prohibited from forming LLCs.
Now, let’s dive deeper into the truths about LLCs by gaining an understanding of the LLC advantages and disadvantages presented below.
Advantages of an LLC
What are the benefits of forming an LLC? LLCs have five main advantages:
Limited Liability Protection: This is the primary advantage of a limited liability company. Members’ personal assets, including properties and savings, are largely protected from the company’s debts and legal liabilities. If the LLC faces bankruptcy or lawsuits, members are not held personally liable for business obligations beyond the company’s initial investment.
Pass-Through Taxation: As mentioned, this is one of the tax advantages of LLC. LLCs do not pay for federal income taxes but instead, business income and expenses pass through to owners and are taxed as part of their personal income. This avoids double taxation for both the individual owners and the company.
Versatile Management Structure: Members are allowed to choose between managing the company or appointing a manager that will handle day-to-day operations. It is not necessary for LLCs to conduct annual shareholder meetings or maintain a board of directors, similar to corporations. To adapt to specific needs and preferences of their owners, this flexibility is granted to LLCs.
Ease of Formation and Administration: Another benefit of an LLC involves the straightforward and fewer formalities for its formation. Compared to incorporating a corporation, forming an LLC requires lesser paperwork and fewer ongoing reporting and compliance requirements. This advantage attracts small business owners to form LLCs instead of other entities.
Allocation of Profits and Losses: A flexibility in how profits and losses are allocated among members is one of the benefits of forming an LLC. This is advantageous for companies with multiple owners who prefer a dissimilar distribution of income from their ownership percentages. This allocation serves useful for tax planning and determining profit-sharing arrangements.
Disadvantages of an LLC
What are the disadvantages of an LLC? Here are five main disadvantages of forming an LLC:
Limited Life: Due to a limited lifespan of approximately 30 years (this varies from one state to another), businesses that seek continuity steer clear from forming LLCs. Unless the company’s operating agreement states otherwise, a limited lifespan entails a dissolution as a result of a member leaving the company or when a specific event occurs.
Self-Employment Taxes: One of LLC downsides is the self-employment taxes on the members’ share of LLC profits. This may result in a higher overall tax burden in comparison to other business structures.
Complexity in Multiple-Member LLCs: Multi-member LLCs make managing a company more complex. Differing opinions on business matters may potentially lead to disputes. A proper management structure and a streamlined decision-making process in the operating agreement can mitigate these concerns.
Limited Options for Increasing Capital: LLCs may not be the best option for entities that foresee raising capital by issuing shares of stock to investors or by going public. LLCs have limited types of equity investments to offer and this is one of the disadvantages of LLCs that makes this business structure less attractive for significantly growing businesses with capital needs.
Differences in State Regulations: One of the cons of LLC is the varying regulations governing LLCs from one state to another. If a business operates in multiple states or if one relocates its business, compliance issues may arise. In addition, this factor may affect the level of legal protection and flexibility available to an LLC.
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Conclusion
Note that LLC disadvantages can be outweighed by its advantages, based on the specific needs and goals of a business. These disadvantages may be mitigated through careful planning, such as structuring the operating agreement to consider addressing potential issues.
Consulting with a professional and seeking both legal and financial advice in forming an LLC will determine how closely a business’s strategies align with its business objectives. Contact us today to discuss. Our team would be happy to introduce you to legal counsel in your respective state.