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What are the Advantages and Disadvantages of Starting an LLC?

What Are the Advantages of an LLC?

 

Tax Flexibility:

 

Typically, the IRS does not consider an LLC to be a distinct separate entity for tax purposes. This means that the members of the LLC will file their profits and losses on their personal taxes rather than submitting taxes for the business.  This is called pass-through taxation, but it’s only one of several options.

 

An LLC also has the option of being taxed as a corporation. While it depends on your individual financial situation, there can be corporate income brackets that make this a cheaper option for you and your business.

 

Generally, members of an LLC will create an Operating Agreement that outlines how the LLC will be treated for tax purposes. Some LLCs are automatically classified as corporations by the IRS, so be aware. Further information on how the IRS classifies some LLCs can be found at IRS.gov.

Less Paperwork:

Compared with C-Corps or S-Corps, LLCs are very flexible. Once again, you’ll want to have an LLC Operating Agreement so you can create rules that govern your business. Otherwise, your company will be governed by the default rules in your state.

 

With less stringent requirements for compliance and less necessary paperwork, LLCs are easier to form and easier to keep in good legal standing.

 

 

Limited Liability:

 

Like corporations, LLCs provide their members protection from personal liability. This means that members are not personally liable for debts and often court judgments incurred by the LLC. Creditors are foreclosed from seeking the personal assets of the LLCs members. It is a meaningful shield not provided in a sole proprietorship or traditional partnership.

 

Please note that maintaining your limited liability status is contingent on keeping your personal assets and interactions completely separate from your business. This means different bank accounts and signing contracts as the business entity, not personally. Also, limited liability protection is usually not applicable in situations involving fraud or other criminal offenses.

 

 

What Are the Disadvantages?

 

 

Self-Employment Taxes:

 

Unless you choose to be taxed like a corporation, LLCs are usually subject to self-employment taxes. This means that the profits of the LLC won’t be taxed at the corporate level, but will pass through to its members who will account for those profits on their personal federal tax returns. Oftentimes, these taxes are higher than they would be at the corporate level. Individual members will pay for federal items like Medicare and Social Security. For this reason, if you do choose to start an LLC, it’s a great idea to speak to a knowledgeable lawyer or accountant.

Confusion About Roles:

Whereas corporations have specific roles (like directors, managers, and employees), LLCs generally do not. This can make it difficult for the company and especially investors to know who’s in charge, who can sign certain contracts, etc. However, much of this confusion can be avoided by creating a strong LLC Operating Agreement.

Limited Life:

In many jurisdictions, if a member departs the LLC, the LLC ceases to exist. This is unlike a corporation whose identity is unaffected by the comings and goings of shareholders. Members of LLCs can combat this weakness in the Operating Agreement.

 

Is an LLC Right for My Business?

LLCs give you a great combination of flexibility and protection. They shield members from personal liability while affording them an array of tax options.

 

Of course, an LLC might not be right for your business. If you're having reservations, check our article of the tax considerations of each business type. Then, once you feel you’ve made the right decision for your business, visit our Incorporation Center and form your business today. If you're ready to get started, visit our LLC Map for a rundown of everything you’ll need in all fifty states. If you’d like more general information about starting a business, be sure to check out our guide.