Hybrid Forms of Ownership

An LLC is a type of business entity that is legal under a statute in each state. Small-business owners appreciate many of the features of an LLC, such as the operational flexibility and tax efficiencies of a partnership, as well as the limited liability protection of a corporation. Although LLCs are legal in all states, each has its own regulations regarding the formation and operation of LLCs. Those who are interested in forming this type of business entity should review the statutes before starting an LLC.

Advantages of an LLC

Business owners can take advantage of a number of benefits when forming an LLC. One of the key benefits is limited personal liability, which means the owners of the LLC, called members, aren't held personally responsible for any business debts or legal action. If the LLC is sued or incurs debt, the members are only responsible up to the amount of their investment. However, as the name suggests, the members are still responsible on a limited basis, so they may not be protected from wrongful acts, such as those committed by other members or employees.

Another key benefit of forming an LLC is simplified record keeping. It is much easier to operate an LLC than it is to operate an S corporation because there are fewer startup costs and less paperwork required to register. Although an LLC isn't legally required to submit formal documentation, it is still important for the members to maintain proper business and financial records. If there is any suspicion that the members of an LLC are mingling business and personal funds, the state can legally reclassify the business, which will place more personal liability on the members.

LLC members also have fewer restrictions placed on the sharing of the business profits. In a corporation, the default for sharing profits is based on each shareholder's percentage of ownership, but LLC members can share profits as they wish. Certain members might contribute to the business in different ways, such as one member offering capital and another offering more sweat equity. The members can decide who receives what portion of the business losses or profits.

Disadvantages of an LLC

One of the disadvantages of forming an LLC is the potentially limited lifespan. During the formation process, the members of an LLC must include a duration for the business. In some states, the option of perpetual life isn't an option. If a member dissociates themselves from the business or passes away, the LLC may be automatically dissolved, which will require the remaining members to fulfill any outstanding business and legal obligations. Since the lifespan of the business could be shorter, it's important to review the requirements in your state before forming an LLC to make sure you fully understand the terms for dissolution.

The members of an LLC are also classified as self-employed, which means they are subject to self-employment tax contributions to Social Security and Medicare. Additionally, the LLC's net income is subject to self-employment tax.

The members of an LLC can manage and oversee the business operations directly. This is different from a corporation, because the shareholders in this type of business are required to elect a board of directors, based on various state charter laws. This board must be organized under each state's charter, as well as hire corporate officers. These officers are responsible for managing the business in the best interest of the shareholders. Corporations also have a different tax liability level than LLCs and LPs.

Advantages of an LLP

One of the benefits of forming a limited partnership is referred to as single taxation. All business losses and income are passed through the business to the partners, which must be reported on the partners' personal income tax returns. Those amounts are split by each partner's interest in the business. A limited partnership also provides limited personal liability to all partners, protecting them from:

  • Company debts.
  • Legal obligations.
  • Negligent acts of employees or other partners that fall outside of their control.

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