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Starting a company can create many question marks, especially around taxes and legal liability. Fortunately, a limited liability company (LLC) can simplify tax filing and reduce the legal liability of its members.
For many business owners, forming an LLC is an easy choice due to the protections that are provided. In addition, organizing an LLC is often relatively simple and inexpensive. However, LLCs have pros and cons, so they won’t necessarily be the best choice in every situation.
Limited Liability Company explained
A limited liability company (LLC) is a business entity formed in the United States. LLCs can be organized in many ways, such as a single-member LLC, a multi-membership LLC, or a member-managed LLC. Members can include individuals, corporations, or even other LLCs.
LLCs are organized at the state level, so laws around LLCs may vary. People often form LLCs in their primary state of residence, though you might be able to form an LLC in another state. Forming an LLC in another state can have certain advantages in some cases, such as favorable tax treatment compared to one’s home state.
Typically, forming an LLC requires certain documentation, such as articles of organization. Other documents, such as an operating agreement, are also usually required.
What is the purpose of an LLC?
People tend to form LLCs at least partly for the protection they provide. When someone is a member of an LLC, their assets are kept separate from the business’s assets. Thus, the LLC can prevent the members’ assets from being seized by creditors. The same is true in the event of a lawsuit.
LLCs also have tax advantages; avoiding double taxation is their main benefit. Income for corporations is taxed both at the corporate level and on shareholders’ tax returns. However, LLCs are not required to pay federal taxes directly. Instead, profits and losses are reported only on the tax returns of an LLC’s members.
The various benefits of the LLC have made them one of the most widely used business entities in the U.S. They are even useful when they have a single member due to the separation of business and personal assets. Thus, entrepreneurs and self-employed individuals often decide to form an LLC.
Pros and cons of forming an LLC
While there are several benefits of forming an LLC, one should be aware of the potential downsides before deciding to organize one.
- Separation of assets: LLCs can protect members by separating business and personal assets. Thus, members’ personal assets cannot be seized by creditors or due to lawsuits.
- Tax advantages: LLCs can avoid double taxation, unlike corporations, which are often taxed at the corporate and shareholder levels.
- Flexibility: LLCs tend to be subject to fewer regulations than corporations, allowing for greater flexibility in their management structure.
- Easy to start: LLCs tend to require less paperwork and fewer fees to start when compared to corporations. However, paperwork and fees vary by state.
- Piercing the veil: While LLCs can protect the personal assets of their members, that protection isn’t always guaranteed. For example, this can happen if the LLC’s members do not clearly separate their business and personal finances. Members might also not be protected in cases of fraud.
- Not as resilient as corporations: In some states, an LLC might be dissolved if a member leaves the company or passes away. In this case, any remaining members must form a new LLC. Corporations can continue even if someone leaves the company or dies.
- Tax disadvantages: LLCs have tax advantages, but they also have potential disadvantages for taxes. For example, members must pay Social Security and Medicare taxes on the business’s net earnings if an LLC is taxed as a partnership. As the business grows, the LLC could have a very large quarterly tax bill.
LLCs vs. corporations
There are many differences between LLCs and corporations. As mentioned earlier, one of the key differences between LLCs and corporations is how they are taxed. LLCs often avoid double taxation, while corporations may have to pay taxes twice.
LLCs may also be subject to fewer regulations than corporations, allowing for increased flexibility. For instance, LLC members have greater freedom in determining how the company should be governed as long as it complies with state law.
Incorporating a business also requires a different set of documentation than organizing an LLC. Corporations primarily have articles of incorporation instead of articles of organization. A corporation is said to be owned by shareholders if it is publicly traded. On the other hand, an LLC is owned by a membership or LLC interest.
Limited liability companies or LLCs are business entities formed in the United States. LLCs have several advantages. One of their main benefits is the separation of business and personal assets. Their other important benefit is the possibility of avoiding double taxation.
LLCs are also relatively cheap and easy to organize; a single person might often create an LLC for their business. The protection LLCs provide and the ease of organizing one has made them one of the most widely used business structures in the U.S.