1. What is an LLC
2. Advantages of an LLC
3. Disadvantages of an LLC

To give an LLC overview, you will have to understand a few things:

  • What is an LLC?
  • Why do LLCs exist?
  • Who should consider an LLC structure?

Formed in the 1970's, LLCs are a relatively new business formation type.

What is an LLC

A Limited Liability Company is a business structure first recognized by the IRS in 1980. In the 1970s, Wyoming and Florida introduced the LLC structure, and most of the other states enacted it soon after that. An LLC blends benefits of a corporation and a partnership or sole proprietorship. Like a corporation, members (LLC owners) have limited liability protection while avoiding double-taxation. Instead, they have pass-through taxation like a partnership or sole proprietorship.

This business formation exists to allow business owners to operate their business without some of the red tape associated with corporations while having protection for their assets from business debt. While partnerships and sole proprietorships are pass-through entities and do not pay taxes at the entity level, the owners do not have limited liability protection.

Likewise, though a corporation features limited liability protection for its shareholders, it is subject to double taxation. A corporation can experience pass-through benefits through an S Corporation election; however, it does not get the same tax treatment as an LLC. LLC members have flexibility in how they run the company. The members can manage it, or they can appoint someone to manage business operations. Depending on what way the members decide, the LLC is either member-managed or manager-managed.

To form an LLC, a business owner must file Articles of Organization with the Secretary of State. LLC members have flexibility when implementing their management structure. The operating agreement outlines essential member guidelines such as:

  • Outlining whether the LLC is member-managed or manager-managed.
  • Specifying member rights and compensation.
  • Communicating ownership percentage for each member.
  • Conveying profit and loss distribution among its members.    
  • Laying out rules for transferring ownership

If an LLC does not have an operating agreement or if the agreement does not address specific factors, then the state's provisions prevail. Compared to the corporate structure, LLC formations are straightforward.

Advantages of an LLC

An LLC has several advantages.

  1. LLC members enjoy limited liability protection, like that of a shareholder in a corporation.
  2. LLC members share in the profits and the tax deductions, however; they receive protection from company liabilities and each other's debt.
  3. LLCs offer a relatively flexible management structure.
  4. LLCs pass-through profits and losses to their members. Corporate structures are taxed at the entity level and employee level. For instance, an employee-shareholder is subject to payroll tax (as an employee) and dividend tax (as a shareholder). LLC members report profits and losses when they file their taxes.  
  5. Members of an LLC have flexibility in dividing the profits and losses.

Disadvantages of an LLC

LLCs have several small business advantages; however, there are disadvantages to forming an LLC. When evaluating your business requirements, analyze both the pros and the cons.

  1. Limited liability companies are typically more complicated to form compared to a sole proprietorship or the general partnership. However, LLC formation process is not as complicated as creating a corporation. Each year a limited liability company must pay a filing fee to the Secretary of State to upkeep their LLCs, file informational returns to the IRS, and filing of a state tax return.
  2. In certain jurisdictions, single-member LLCs may not get the same level of limited liability protection as that of a corporate entity.
  3. In many states, if you have a company that renders professional services, you cannot set up an LLC because the limited liability does not extend to those types of companies. Instead, you must set up a Professional LLC (PLLC). PLLC structures do not benefit from liability protection. For instance, doctors do not benefit from this liability shield due to opposition primarily from the trial lawyers.
  4. LLC profits may be subject to self-employment taxes. This can be a disadvantage depending on your income bracket.

LLCs are suitable for many small business owners. Still, you need to consider all the nuances that come with an LLC and make sure it is a structure that fits your business needs.

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