When it comes to creating a business entity, most business owners opt to go with an LLC. However, every business has different needs, circumstances, and goals. An LLC may not necessarily be the best entity to go with for all business owners. Before deciding to form an LLC, it’s important to learn what the advantages and disadvantages of an LLC are.
The Advantages of Forming an LLC
1. Doing business as a sole proprietor can be very risky as a lawsuit can result in your personal assets being seized. An LLC separates your personal assets from the business so that you are protected from the worst-case scenario.
2. The tax structure of LLCs is easier to deal with. An LLC is taxed as a pass-through to the owner by default. In this case, profits and losses are passed through to the owner as opposed to the business entity itself. Other types of business entities have far more complex tax structures. Business owners also have the option to file as a corporation when forming an LLC.
3. LLCs are easy to work with when there are multiple partners. By going with the pass-through structure, the owners can evenly distribute the income to each other after the losses are deducted. This makes it easy to avoid headaches, misunderstandings, and arguments.
4. While an S- corporation has pass-through taxes, owners can pay fewer self-employment taxes by declaring themselves as employees. A big advantage of LLCs is the fact that it can have foreign shareholders while an S corporation prohibits foreign shareholders.
5. There is less paperwork and formalities to deal with LLCs. Corporations have to keep a lot of information like corporate minutes, annual reports, and additional tax records. Corporations are also required to hold regular meetings with the board of directors and shareholders, which can get in the way of running the business.
6. An LLC can be put into a living trust. So if a family member wants to pass down the business through a trust, it becomes so much easier to do so. Only certain types of trusts are allowed with S-corp holdings. A very knowledgeable trust and business law attorney will need to be hired to make sure that everything gets transferred without any issues.
The Disadvantages of the LLC Business Structure
1. A major disadvantage of an LLC is that owners may pay more taxes. When setting up as a pass-through to owners, they are subject to self-employment tax. Self-employment tax ends up higher compared to being taxed as an employee. That’s why many business owners may see it as more favorable to go with an S-class corporation.
2. It can be harder to attract investors with an LLC structure. Many investors will favor a C-corp or S-corp because of the way it is structured. Everything, including the way these entities are taxed, how they work with shareholders, and their ability to move towards an IPO, makes them more preferable. That said, most small business owners may not have to worry about these factors.
3. There tend to be high filing and renewal fees associated with forming and maintaining an LLC. It depends on the state you are in, so you’ll want to check official government sites for more information. If you are a sole proprietor and feel like there is no big reason why you should go with an LLC, it may not be worth it.
4. Good records must be kept when there are multiple owners in an LLC. When filing as a corporation, records for the corporation itself and owners must be kept separate. This isn’t necessarily easier than the other corporate structures. However, it’s something to be aware of if you are currently a sole proprietor that won’t gain any big advantages by going with an LLC structure.
5. When it comes to things like lawsuits, LLCs are not treated as corporations. So, if there is litigation that is out of state, you may not have a choice regarding where the case will be held. Business laws differ depending on the state you are operating in, and this can be very disadvantageous to your case. A corporation usually has more say in where litigation will be held.
Now that you know the advantages and disadvantages of opening an LLC, you can make an informed decision on whether the business structure is right for you. Because an LLC structure is easy to work with and manage, most small business owners choose it over the other options. However, as your business grows, there are many benefits to switching over to a new corporate entity structure.