Disadvantages of an LLC: Everything You Need to Know
There are some disadvantages of an LLC that you need to consider before choosing this type of structure for your business.3 min read
There are some disadvantages of an LLC that you need to consider before choosing this type of structure for your business. Though an LLC is a popular choice because it combines the advantages of a sole proprietorship with those of a corporation, you'll also find some drawbacks associated with this business type. Consider the pros and cons carefully before moving forward with creating your LLC.
LLCs: An Overview
One of the first steps to forming a business is choosing which structure is right for you. Each type has pros and cons, and you'll have to live with the drawbacks and perks for the business's entire life.
Sole proprietorships, LLCs, and corporations all have different rules for paying taxes, protecting personal assets, and reporting and creating bylaws. LLCs, for example, share some of the control benefits and limited liability protections that you find in a sole proprietorship. They also provide the tax and liability advantages associated with a corporation.
These perks are fantastic, but there are some reasons why forming an LLC might not be the best choice for you. For example:
- LLCs must file articles of organization and other documents outlining how the business is operated and shared among the participating members.
- Your income as an LLC member may be subject to self-employment taxes.
- LLCs are limited in terms of equity and attracting new investors.
These and other disadvantages of forming an LLC are outlined in greater detail below.
Disadvantages of an LLC
Though LLCs aren't as rigidly structured as corporations, they do face stricter administrative requirements and government regulations than sole proprietorships or limited partnership. LLCs are also at a disadvantage compared to other business structures in terms of filing fees, taxes, record-keeping requirements, and individual members' rights and responsibilities.
Fees and Government Regulations
Partnerships and sole proprietorships are a better choice than LLCs in terms of filing requirements to start your business. The filing fees associated with an LLC are also more expensive than the fees for these other business types.
Moreover, overall operating expenses are higher for LLCs. Proprietorships and general partnerships, for example, don't have startup or annual fees, but LLCs have to budget for these costs.
If you want to start an LLC, you'll also need to check the laws in your state and local area to determine whether this business type is profitable for you. For example, in some areas, an LLC ceases to exist if a member leaves.
LLCs are at a tax advantage compared to corporations, which must pay taxes based on what each individual member earned and on the corporation's total profits. In an LLC, only the individual members are taxed based on their adjusted gross income.
Unlike a sole proprietorship, however, an LLC owner may have to pay individual unemployment compensation. Also, unlike a corporation, an LLC owner may have to pay self-employment taxes. Individual LLC members are accountable for their own Medicare and Social Security payments as well.
Though only LLC members are taxed, those individuals may actually end up paying more in taxes than they would if they worked as part of a corporation.
LLC owners have to keep their personal business separate from the LLC's operations. This means that the LLC has to keep its own records and should record the minutes of meetings (note that this is only required by law for corporations).
You must also keep personal and business funds separate and carefully document the LLC's financial records apart from your own. This means setting up a corporate account for all business and deposits related to the LLC. Note that some banks charge a fee to set up an account for an incorporated business.
Division of Responsibilities Among Members
Many LLCs don't have formal positions, such as directors, executive officers, and managers. This is beneficial, but it can lead to some confusion about who's responsible for certain parts of running the business. If you form an LLC, you can create an operating agreement to avoid this disadvantage.
Should You Form an LLC?
Though an LLC might not be right for your business, they do offer many benefits compared to sole proprietorships, limited partnerships, and corporations. LLCs offer greater flexibility compared to corporations and more protections compared to sole proprietorships.
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