Starting a business requires answering a lot of questions, particularly when you are just getting started. Deciding what type of organization to form is one of the big ones. If you have been doing some research, you may have learned that many small businesses choose to form as LLCs. But why? Well, there are a number of advantages for your business that come with LLC status – advantages that are worth considering if you want to set your new business up for success.
4 Major Advantages of Incorporating as an LLC
1. Limiting the personal liability you have from your business.
There are some big problems that can arise from operating your business as a sole proprietorship. As a sole proprietorship, you and your business are considered the same entity. If you are operating a partnership, the business, you and your partners are all considered the same entity. If you run into a situation where someone sues your business for negligence and you lose the lawsuit, your personal assets could be considered part of the business and you could lose some or all of them.
One of the biggest reasons corporations were developed was to create what is known as the “corporate veil”, the legal gap between the assets of a corporation and the assets of those who operate the corporation. An LLC gives you this veil. If you lose a lawsuit the court will only allow the winners to access the assets of your LLC – as long as you do a respectable job of keeping your personal assets and business assets separate.
The corporate veil also protects you from the debts of your business. Say you take out a big loan and cannot pay it back – leading the lender to seize some of your assets to pay back the debt. They will be limited to your LLC assets, so you don’t have to worry about losing your family home, personal assets and other belongings.
2. Gaining tax advantages.
LLCs operate in an interesting way when it comes to taxes. Unlike other types of business entities, LLCs do not have a specific classification in the federal tax system. That lack of classification frees you up to choose which type of status you want to use for your business. You can choose to be taxed like a sole proprietorship, an S corporation, a C corporation or a partnership.
Which tax status you adopt should depend on the way your business operates and the advice of your tax specialist, but there are some general concepts that are worth considering. By default, your LLC will be taxed like a sole proprietorship unless you have more than one owner or not. That means that your LLC will not pay corporate taxes – instead, you will be able to use “pass-through” taxation. Your financial information will pass through your LLC and into your personal tax information. You will pay your personal income taxes on the profits you make.
If you choose S corporation tax status, you may also be able to take advantage of pass-through taxation but you may not be able to. It all depends on the nature of your corporation. If you choose C corporation tax status, you will have to pay tax twice – once on the corporate level and once on the personal level.
As you can see, the automatic pass-through status usually works best for the small business owner. However, you would still be wise to talk to a tax professional just to make sure that you are positioning your business for an optimal tax situation.
3. Flexibility for ownership, profit distribution and management.
One thing that many LLC owners appreciate is how flexible their business structure can be. Other types of corporations must follow very specific rules about how they do things to adhere to the law, but LLCs are often free to do more of what they see as right for their particular business needs.
Take ownership structures, for example. With an S corporation, you have multiple restrictions on ownership structures. S corporations are not allowed to have shareholders from outside of the U.S. They can’t have over 100 shareholders. But LLCs are not limited by the restrictions. You can have as many shareholders as you want and foreign shareholders are fine.
The way you distribute your profits is more flexible. With some corporations, you have to distribute profits according to rules – like distribution based on ownership percentages. But you and your partner may have decided that the fairest distribution would be different, such as if one of you has put in more work, time or money during the startup phase. If you both want to distribute more of the profits to the more involved partner, you can do so without restrictions.
Another flexibility that comes with an LLC is the way you manage your organization. With a corporation, you must use a specific management structure that includes a board of directors and officers. Each year the owners need to hold a meeting to choose who the directors of the corporation will be and how the company will run the following year.
For a small business, this structure does not make much sense. Fortunately, as an LLC you don’t have to do any of these things. You can manage the business however you like.
4. Less fuss with paperwork and fees.
Running an S or C corporation typically requires a lot of paperwork and extra costs such as state corporate taxes and filing fees. With an LLC you usually don’t have to go through so much paperwork each year. You do have to do more than you would with a sole proprietorship, but far less than you would with a more formal corporate structure.
An LLC Might Be Right for Your Business
If you are starting a small business, it is certainly worth considering whether an LLC would be the most beneficial corporate structure for your needs. It may be slightly more involved than a sole proprietorship, but the benefits often more than make up for the extra work.