Choosing Your Business Structure: The Pros and Cons of LLCs
Limited liability companies, or LLCs, are a popular choice for business entity formation, especially for small business owners. There are good reasons for that, too. They offer liability protection, management flexibility, and tax advantages. However, that doesn’t mean there aren’t any potential downsides. Understanding the pros and cons of LLCs is an important part of deciding whether they’re right for your business.
Here are the advantages and disadvantages of LLCs.
Advantages of LLCs
1. Limited Liability
The most obvious advantage of an LLC is right in the name—limited liability. The LLC structure limits the owner’s potential for liability. Because an LLC is a separate legal entity from its owner, it owns its own assets, enters into its own contracts, and is liable for its own debts—not the owner or owners.
For example, an owner can’t be held personally liable for damages caused by or related to the business. If someone is injured on company property or hurt using one of the LLC’s products, they can’t go after an owner’s personal assets.
Some other potential factors they couldn’t be held personally liable for are:
- Unpaid business debts (unless you personally guarantee them)
- Vendor disputes
There are some exceptions, however. It’s limited liability, not zero liability. Exceptions typically come into play when there’s criminal or tortious activity, in which case the corporate veil can be pierced and hold the owner liable. This could include an LLCs
- Whose purpose defeats public interest
- That Commits fraud
- Circumvents federal or state law
- Shelters tax abusive schemes and evasion
It might also happen due to:
- Not complying with LLC formalities
- Not informing a third party that it is dealing with an LLC
- Not establishing sufficient separation between LLC members and the entity itself
Members may also be liable for:
- Written promise to contribute cash and property or to perform services
- State taxes
- Environmental torts of the entity
- Wrongful distributions
But as long as the owner is fulfilling their personal obligations and not engaging in any illegal activities, they will generally be protected from personal liabilities.
2. Ease and Simplicity
Setting up and administering an LLC is much easier than most business entities. LLCs are created under state law—and most states allow an LLC to form for any lawful purpose.
To form an LLC, you must file the articles of organization with the state’s secretary of state. These will only need to contain general information about the LLC, such as its name, registered agent, principal office, business purpose, and duration. These can generally be filed online quickly and easily.
Once your articles of organization are accepted by the state, the LLC becomes a separate legal entity. Most states will impose an annual registration or renewal fee, but as with creating the LLC, this is a simple process.
3. Flexible Tax Structure
Unlike most other business structures, LLC owners can elect to be taxed as one of several business entities. These include:
- Disregarded entity (If owned by a single person, or married couple in community property states)
- Partnership (If there are two or more owners)
- C corporation – if checking the box on form 8832
- S corporation – if making the election on form 2553
A single member LLC is taxed as a disregarded entity, there are major advantages to that method. Any business income or loss is passed-through” to owners and reported on their personal income tax returns and taxed at the individual level. However, even when choosing one of the other options, LLCs can still offer advantages over other entities.
4. Unrestricted Members or Partners
Single-member LLCs are very common. These can even be owned by other LLCs, single-member or otherwise. That multilayered company strategy is often employed in certain industries, such as:
- Real estate
- Segregating product lines and services
- Branded retail products
But although single-member LLCs are common, there is no restriction on the number of members or owners involved. This is contrasted with other business entities, such as:
- limited partnerships (LPs), which must have at least one general partner
- S corporations, which can have no more than 100 owners , and restricts foreign ownership
What’s more, in the case of multi-member LLCs, there are flexible rules on how members receives distribution of capital and business profits. Any and all members can be paid less or more than their respective share of ownership. There is even a tax write-offs for business expenses or reimbursements for if members decides to receive guaranteed payments instead of the normal distributions.
6. Fewer State Requirements
LLCs face fewer state-imposed compliance requirements than corporations, general partnerships, or S-Corporations
In most states, there’s no legal requirement for an LLC to hold annual meetings. LLCs are also not required to have a board of directors, perform as much paperwork, or keep as many records as a corporation would.
Other aspects offer further flexibility, such as allowing LLC investors to have little or no say in the daily decisions of the business—as long as this is stated in the operating agreement.
Disadvantages of LLCs
1. Filing and Licensing Fees
There is a fee to file any new LLC with a state and usually an annual filing fee to keep the LLC in good standing.
- The initial filing fee typically ranges from $50 to $500.
- The annual filing fee ranges from $0 to $820.
As you can see, there can be a broad difference from state to state. Some states also have further requirements, such as a local agent, which can add more fees to state filing costs. It’s important to research the specifics of the state you intend to form your LLC in. You can find that information on your state’s secretary of state website.
Regardless, the cost to establish and maintain an LLC is usually much lower than other structures like a C corporation or an S corporation.
2. More Tax Forms For Multi-Member LLCs
The process of preparing taxes for a Multiple-Member LLC can be complicated. Even if your LLC taxed as a pass-through entity, and even if there is no money going in or out of the business, the LLC will need to file Form 1065 and dispatch Schedule K-1s to each member of the LLC . These K-1s are then filed with every owner’s personal tax return.
All the tax forms for an LLC may include:
- Company tax filing
- Franchise and excise taxes (if applicable)
Many states, such as California, New York, and Texas, also require LLCs to pay a franchise tax or “capital values tax.”
3. Member Salaries Can Complicate Taxes
Right now, as far as taxes are concerned, LLC members or owners can’t collect salaries from their LLC. Members can still receive money from the LLC, but it’s the form of distributions. Members are then taxed on their share of profits, not how much they actually received.
Guaranteed payments can create an exception to this. That occurs when an LLC pays members to reimburse them for the use of their capital or for a service or other benefit they provide to the company.
4. Raising Money
When setting up a business, you may want to raise money from outside investors. Operating an LLC can make that more difficult. Because of the pass-through nature of LLCs along with the flexibility of their managing members and limited liability, outside investors may see them as a riskier gamble than a more traditionally structured business, such as a C-Corp.
And because LLCs can’t issue shares, outside investors can only invest in an LLC through a buy-in as a member or through purchase of membership interest. This makes it hard to raise equity capital as a starting entrepreneur normally would.
However, if that isn’t a concern, then this potential disadvantage isn’t really a problem.
Is an LLC right for you?
There are plenty of pros and cons for LLCs, advantages and disadvantages that come with the territory. However, in many cases, the pros outweigh the cons. The LLC business structure is often ideal for entrepreneurs who want to establish a business as a separate legal entity, but retain limited liability and have the option of pass-through taxation.
The pros and cons of LLCs make it clear that for most entrepreneurs, it’s the right call. At the end of the day, they’re almost always the cheapest, easiest, and safest business entity to create and maintain.
There are possible downsides, yes. But by and large, that just means you have to do a little more research in order to avoid them. LLCs offer an excellent opportunity to customize your approach, highlighting the advantages and minimizing the potential risks or expenses.
I’m here to help.
If you aren’t sure whether an LLC is the right structure for your business—or if you want some help navigating the process of setting it up—I’m always on hand. I’ve helped countless business owners with their LLCs before, and I can help you, too.
Click Here to get in touch. I’m looking forward to talking with you!