Are you an entrepreneur who’s just starting out and wondering what type of business structure you should choose? You may already know that the most common structures are sole proprietorship, limited liability company (LLC), partnership, S corporation, and C corporation. As you make your decision, it’s worth considering the pluses and minuses of an LLC structure, even if you’re just getting your company off the ground.
Key Points
• With an LLC, personal assets like homes and cars stay protected if the business faces lawsuits or can’t pay debts. That’s not the case, though, if owners personally guarantee the business loans.
• LLC profits generally flow through the company to its members and get taxed at individual rates, but there is an option for different tax treatment with potential savings.
• Setting up and running an LLC involves more work than operating as a sole proprietor but far less complexity than establishing a full corporation.
• Ongoing costs go beyond the initial setup expenses to include yearly fees, licenses, permits, and agent services.
• Losing a member might require the LLC to dissolve the business and refile its documents, unless the operating agreement already dictates how to handle departures.
What Is a Limited Liability Company (LLC)?
An LLC is a type of business structure that protects the owner’s personal money and property if their company runs into any type of legal trouble. For example, if your business is found liable in court or defaults on a large debt, your house, car, and personal assets are shielded from legal seizure.
Among the LLC’s advantages are more flexibility when it comes to taxes and, compared with some alternatives, less paperwork for daily operations.
Pros of Forming an LLC
Here are some of the top benefits of a limited liability company.
• Limited personal liability: Incorporating as an LLC protects your personal assets should your company run into legal trouble or be unable to pay its debts. However, if you’re required to personally guarantee loans taken out in the company’s name (e.g., a small business credit card), you would be directly responsible for any debts.
• Tax advantages: The tax benefits of an LLC are notable. By default, all profits are passed through the company to members of the LLC and taxed at their individual rates. If you prefer, though, an LLC allows you to opt for taxation as an S corporation, potentially limiting the self-employment taxes you’ll have to pay.
• Stated roles for multiple LLC members: Another LLC advantage is that you can designate multiple owners upfront. This can help you avoid some business headaches over owners’ duties and domains. As long as you have a solid operating agreement, it’s easy to legally establish everyone’s responsibilities and profit allocations.
• Simpler to establish and run than a corporation: The costs and paperwork involved in setting up an LLC go beyond what’s required for a sole proprietorship, but aren’t nearly as intensive as the process of creating a corporation.
Cons of Forming an LLC
There are also aspects of an LLC structure that may be less appealing.
• Tax disadvantages: If you’re treating your LLC as a pass-through entity, you’ll pay full self-employment taxes on the first $168,600 of your net income. To pay less, you’d have to elect for your company to be taxed as an S corporation. You’d then be able to draw a reasonable salary (which is subject to self-employment taxes) and distribute to yourself and other members any remaining net profit (which isn’t subject to self-employment taxes).
• Limited continuity: If a member of the LLC leaves, state law may call for dissolution of the original LLC. This would mean you’d have to refile the needed paperwork and go through the entire process again. To avoid such problems, the LLC’s solid operating agreement should contain some provisions spelling out how the business would handle this development.
• Ongoing fees: Even after you pay the initial filing fee to your state, you’re likely to have additional fee obligations. Examples include payment for registered agent services, attorney fees for drafting an operating agreement, annual report charges, licenses, permits, and more.
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LLC vs Other Business Structures
As mentioned above, LLCs are just one type of business structure. An individual business owner can also choose to operate their company as a sole proprietorship, S corporation, or C corporation.
• Sole proprietorship: This is the easiest business structure to adopt. It forms automatically when you start selling goods or services; no formal filing is required. Legally, there is no separation between you and your business, so you’ll be personally responsible for repaying small business loans and covering any court judgments against your company. This exposure puts all of your personal assets at risk.
• S corporation: When operating as an S corporation, you can give yourself a salary and pay payroll taxes only on that amount. Income beyond your salary that is distributed to you as profit is not subject to the same self-employment tax.
• C corporation: A C corporation is taxed independently of its owners. Like all corporations, it offers liability protection. Compared to an LLC, there are more rules and paperwork involved, and it doesn’t offer the same amount of tax flexibility. A C corporation may be a good option if you’re trying to avoid startup business loans and plan instead to raise capital from other sources.
Overall, an LLC is a good middle ground for many business owners. LLC status does call for more paperwork and legal preparation than a sole proprietorship, but the advantages of an LLC company — including liability protection and tax flexibility — may make the extra effort worthwhile.
It’s also worth considering that lenders may prefer LLCs over sole proprietors when it comes to small business loans and business lines of credit, as setting up an LLC may help convey that your company is fully established. Taking these steps to protect yourself may signal to others that you’re a responsible business owner.
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Is an LLC Right for Your Business?
An LLC may be the best fit for your business if you want to protect your personal assets but don’t want the heavy lift of forming a corporation. Many small businesses choose this structure because an LLC is much simpler to form and more customizable (e.g., the option to be taxed as an S corporation).
However, there are also reasons to consider C corporation status. If you plan on raising money from investors, having a C corporation makes it easier to divide equity among them and to issue different classes of stock. The downside is that forming and maintaining a C corporation is costlier; it requires more extensive record-keeping, reporting, and operational processes.
How To Form an LLC
To form an LLC, you’ll need to do the following:
• Choose the state you want to be based in. State laws set the rules for LLCs, so be aware that your selection may have financial consequences.
• Pick an appropriate name. Note that your state may have naming rules, plus you’ll want to confirm there’s no other company with your preferred name, so check the Secretary of State’s website or call the office to make sure.
• File articles of organization with your state. You’ll probably have to pay a filing fee.
• Hire a registered agent to receive all legal correspondence. If your LLC has multiple members, you can designate one of them as the registered agent.
• Put an operating agreement in place. This ensures everyone knows their role in day-to-day operations.
• Get an employer identification number (EIN) from the IRS. It’ll enable you to open a business checking account if you don’t already have one.
The Takeaway
The benefits of a limited liability company structure for a small business are worth considering. Though shifting your business from sole proprietorship to LLC involves extra paperwork and fees, having the LLC’s liability protection and tax flexibility may compensate.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What are the advantages of an LLC company?
Forming an LLC has a few advantages. For starters, it’s easier to form than a corporation, and it protects you from personal liability should your company fall behind on debt payments or lose a lawsuit.
What are the disadvantages of forming an LLC?
LLCs must pay initial filing fees as well as annual fees for reports, license renewals, and more. Both the amount and the timing of those fees varies by state. In addition, an LLC business owner is considered self-employed; this means you’ll owe self-employment taxes for Social Security and Medicare on your company’s profits. However, an LLC can choose to be taxed like an S corporation, which may introduce ways to lower the tax bill.
How does an LLC compare with a sole proprietorship?
It requires more effort to form an LLC than a sole proprietorship, but there are many benefits of an LLC as well. Perhaps the biggest one is that the owner’s personal assets are not at risk in the event of a lawsuit or debt default.
A sole proprietorship can be formed very fast. You have sole proprietor status as soon as you start to sell your goods and services. However, this business structure doesn’t provide any legal safeguards to the owner.
Do LLCs pay more taxes than other business types?
You may end up paying more to the IRS, thanks to self-employment tax rules, but you do have options. For example, you can choose for your LLC to be taxed as an S corporation, which could mean you’d owe self-employment taxes only on the wages you draw.
Is an LLC the best business structure for beginners?
As always, it depends on your business needs and financial situation. Setting up as a sole proprietorship is the easiest, because the structure requires no official paperwork or fees. LLCs offer liability protection and tax options, but take more time and money to establish. New entrepreneurs should consider how soon they want to start doing business and whether they expect to take on partners or investors.
Photo credit: iStock/Igor Suka
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