LLC Advantage and Disadvantages: Everything You Need to Know
There are several LLC advantages and disadvantages to consider when operating a limited liability company.3 min read
2. Advantages: Tax Flexibility
3. Advantages: Less Paperwork/Formalities
4. Advantages: Limited Liability
5. Advantages: Allocation Flexibility
Figuring out what type of business to form can be confusing, as there are many to choose from. The structure you choose will determine how taxes are paid, the type or amount of regulations that occur, and personal liability. One of the most common types of businesses is a limited liability company, or LLC.
Before forming a limited liability company, the potential business owner should familiarize themselves with the advantages and disadvantages of forming an LLC. These should be compared to other forms of businesses. There are many advantages an LLC has that a partnership or sole proprietorship does not have. That said, not every business is an appropriate candidate for an LLC.
The LLC is a newer type of business form compared to older partnership or corporation forms. The limited liability company will be formed through the state where business will be conducted. An Articles of Organization must be filed and the fee paid.
Advantages: Tax Flexibility
An LLC isn't a separate entity from its owners when it comes to tax purposes according to the IRS. This means the LLC will not be taxed directly by the IRS initially. LLC members can decide how they want to be taxed. The options include the following:
- Single member LLC - This type of business is taxed similarly to a sole proprietorship, where profits or losses from the company are taxed on the member's individual tax return.
- Partners in an LLC - Members choose to be treated as a traditional partnership when it comes to taxes.
- LLC filing as a corporation - Members of the LLC can decide to file like they're a corporation.
The tax for a business for a single member or sole proprietorship LLC is calculated with Schedule C in addition to their normal tax return. The net income from the business will then be added to the other income of the owner. For multiple-member or partner LLCs, Form 1065 will be used for the partnership tax return. Each person's share of the tax is calculated on Schedule K-1. This will also be included on the owner's tax return. Certain LLCs are automatically considered corporations according to the IRS.
To find out how they classify some LLCs, visit www.IRS.gov for more information. An LLC's tax rate is dependent on what the owner's total income is. As a result, the LLC might pay taxes at a rate that's lower than a corporation. Owners of corporations might be subject to double taxation, but LLC owners do not.
Corporations have to pay taxes on dividend income and corporate net income. Corporations need to pay state corporate franchise taxes in some states. However, not all states require LLCs to pay this.
Advantages: Less Paperwork/Formalities
LLCs are quite flexible compared with S or C corporations. An LLC operating agreement should be in place so the rules can be created to govern the business. If not, the company will be subject to the default rules in their state. LLCs don't need to have annual meetings, strict accounting requirements, or a board of directors. This allows the business more flexibility in how it's run. LLCs are relatively easy to form and keep in good standing legally, as there is less paperwork and strict requirements.
Advantages: Limited Liability
LLCs give their members liability protection, similar to corporations. This means they won't be liable for any court judgments or debts that the LLC incurs. Creditors cannot go after the personal assets of members in the LLC. This protection is not seen in a traditional partnership or sole proprietorship.
However, limited liability doesn't fully protect an LLC's members. If they don't follow particular rules when it comes to business management or if they break the law, they're still liable.
Advantages: Allocation Flexibility
How much money owners invest in their business doesn't need to match their ownership percentage. Members form an operating agreement when an LLC is formed. This states the varying percentages of profits and losses of a company. They are assigned to owners regardless of how much they initially invested.
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