The disadvantage of LLC includes higher cost of formation, operational formalities, legal uncertainty, difficulty in raising capital, and complicated taxation in some cases.

Why Start an LLC

It's important to choose the right type of structure for your business. The way you pay taxes on your business income, the extent of your personal liability for business transactions, and the way your business is regulated depend upon the structure or form of your business.

LLC, or Limited Liability Company, is an easier and simpler form of business than a conventional corporation. Forming an LLC involves less paperwork than what is required for a full-fledged corporation. Due to less stringent requirements, it is much easier to operate.

An LLC offers protection against your personal liability for business obligations. Creditors of an LLC cannot pursue the personal assets of its members. This protection is not available for sole proprietorship and partnership forms of businesses.

For the purpose of federal income tax, an LLC is not a separate taxation entity. So, there is no separate taxation at the company level. The owners combine the business income with their personal income and pay income tax at individual rates.

The LLC members can choose from various ways they would like to be treated for the purpose of taxes:

  • Single Member LLC: An LLC that has a single owner is taxed as if it were a sole proprietorship. The owner includes the net profit or loss from the company in his personal tax return.
  • Partners in an LLC: The LLC members are taxed individually, as in the case of a partnership firm.
  • LLC filing as a corporation: The members of an LLC choose to be taxed as a corporation.

Disadvantages of an LLC

  • Unlike a sole proprietorship and partnership form of business, running an LLC requires you to comply with some additional rules and formalities.
  • The legislation governing LLCs is limited and is not as detailed as corporate law.
  • Due to limited legislation, members of an LLC need to create an LLC agreement.
  • The IRS offers only two beneficial characteristics of a corporation to an LLC. It can choose any two of these four benefits: limited liability, continuity of the company after the exit of a member, centralized management, and free transfer of assets.
  • Unless otherwise provided in the operating agreement, an LLC terminates with the exit of a member.
  • Sometimes, LLC taxation can be more complex than conventional corporate taxation.
  • The pass-through taxation may work against you if your LLC is into international business.
  • Owners of an LLC are liable to pay self-employment taxes on their shares of business income.
  • The owner of an LLC may end up paying unemployment compensation for himself.
  • You need to pay a significant amount of filing fees for forming an LLC.
  • You cannot cash the checks issued to your LLC; you must deposit them into your company's bank account.
  • Some of the banks charge higher fees for corporate bank accounts.
  • The owners of an LLC must keep the company business separate from their personal business.
  • An LLC must keep its own accounts and records, including the minutes of meetings.
  • It must keep its money separate.

Operating Agreement

An LLC operating agreement outlines rights and responsibilities of members and their shares in the ownership of the company.

Recommendation

An LLC can be a good business structure for small businesses with no more than three working owners.

Number of Owners

Although you can register an LLC with a single owner in your state, it must have at least two members in order to get the LLC status from the IRS.

State Availability

  • LLC is a new type of business structure, and the laws governing it are still in the nascent stage.
  • Some of the states do not offer this business structure yet.
  • If you can't register an LLC with your state, you cannot take the federal tax benefits available to an LLC.
  • The states that do not allow LLC registration tax LLCs at a higher rate than partnership firms.

Legal Uncertainty

Some states do not allow forming an LLC for offering certain professional services.

Raising Capital

An LLC may find it difficult to raise capital for its business because it does not issue stocks and bonds.

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