This business structure is attractive for start-ups and growing businesses. Not only is it flexible and easy to start, but it also prevents double taxation.
A business entity can be formed in several ways. One of the top and most popular structures is the Limited Liability Company.
A Limited Liability Company (LLC) is a type of business entity formed to limit the personal liability of the owners, and let the business be taxed like a partnership. Similar to shareholders of a corporation, LLC owners are called members.
Although an LLC is not the perfect form for every business owner, there are great reasons why you should consider structuring your business as such.
Go over the following information to get guidance in determining whether an LLC may be right for your business or not.
Why Choose an LLC for Your Business?
LLCs allow owners, members, or partners to have liability protection while taking advantage of the tax and flexibility benefits of a partnership.
Under this structure, owners are shielded from personal liability for the debts and obligations of the business if proven that they didn’t act illegally or unethically when carrying out the activities of the business. LLC earnings and losses are passed through to the owners as income on their tax returns.
Whether you’re starting a business or have been operating a business as a sole proprietor or partnership, knowing if you need an LLC would benefit you in the long run.
As there are several things to consider when choosing to form a business, let’s go over the best reasons so you’ll figure out why LLC is a better fit for your start-up than other business types.
- Limited Personal Liability
This is the most important reason why you need to form an LLC.LLC limits personal liability and is responsible for its debts.
Because an LLC is legally separate from its owners, only the assets owned by the business are subject to lawsuits or claims of business creditors. While you can lose the money you invest in the company, your assets are protected, and the personal assets of the LLC members cannot be used to collect for business debts.
- Personal Asset Protection
This is one reason why growing start-ups elect to their LLCs into a corporation when it comes to tax purposes.
When you form a business as a sole proprietorship or partnership, all debts, lawsuits, and obligations are also against you. You can’t protect your assets such as your properties, vehicles, or personal bank accounts, from being seized to pay your business debts.
However, if you operate an LLC, you’re secured by a corporate veil that prevents creditors from pursuing your assets.
- Flexible Business Structure
Operating a business as an LLC is more relaxed and has fewer restrictions compared to other business structures.
Corporations adhere to a fixed and formal management structure like having a board of directors, appointing officers, and holding meetings with shareholders.
While corporations issue stock to invite investors, LLCs can expand ownership and bring in other members to generate more investments for the business.
With an LLC, owners have the flexibility to make decisions and run the business. You can easily make changes to the managerial structure or change ownership roles, etc. any time. There’s no need to hold board meetings when making business decisions.
- Flexible Profit Distributions
LLCs have adaptable business structures in the manner they distribute profits to owners.
The options for allocating profits are limitless. It can be shared equally, based on each owner’s contribution or depending on each owner’s involvement in the business.
On the other hand, corporations distribute profits to shareholders based on the shares they hold. Business owners have no control over how profits are allocated to each shareholder in the corporation.
- Tax Benefits
The Internal Revenue Service automatically taxes LLCs as sole proprietorships or general partnerships, depending on its number of owners.
When it comes to taxation, LLCs get the best of the world for they can select how they want to be taxed.
- As LLCs don’t have their federal tax classification, they can choose to adopt the status of a corporation, with options for C corporation or S corporation taxation
- In an LLC, the profits and losses of the business are passed on to the members and owners
- LLCs benefit from the pass-through taxation as this prevents double taxation that occurs in a C-Corp business structure
This means that instead of paying LLC taxes or corporate taxes, the LLC’s income and expenses are passed through the owners’ tax returns.
On the other hand, C corporations get taxed twice: first on the corporate level, then again on the personal level.
- Less Complicated Paperwork
Corporations typically hold regular meetings of the board of directors and shareholders, keep written corporate minutes, and file annual reports to the state. And this means substantial recordkeeping requirements.
Whereas, LLCs have lesser formalities. LLC owners and members hold meetings only when needed and are not required to keep extensive records.
How do LLCs Pay Taxes?
Understanding how your LLC will be taxed is necessary so you can choose the best tax option for your business and avoid possible tax penalties.
LLCs tax depends on whether your business is a single-member LLC or multi-member LLC.
By default, the IRS treats single-member LLCs as sole proprietorships.
This means that the LLC is not required to file a separate income tax return to report income and expenses and does not have to file a return with the IRS. The owner will pay taxes for the business as part of their tax returns.
For sole owners of an LLC, business income and expenses are reported on Form 1040, Schedule C, similar to a sole proprietor. If there are profits in the company’s bank account at the end of the year (after deducting business expenses), the LLC owner will pay taxes to the IRS under their income tax rate.
The IRS treats multi-member LLCs as pass-through entities and as partnerships for federal tax purposes.
Similar to single-owner LLCs, multi-owner LLCs don’t file or pay taxes of their own. Instead, each member pays taxes based on their share of the profits and losses in proportion to their ownership stake in the LLC.
It means that the LLC owners each pay taxes on their income tax returns.
Each member’s distributive share is set out in the LLC’s operating agreement, which is usually in proportion to their initial investment or based on their level of involvement in the business. Thus, each member must pay taxes based on their distributive share.
Why Elect to Have Your LLC Taxed as a Corporation?
Business owners are looking for ways to save money, including the taxes to be paid.
Establishing your business as an LLC and making the election to have it treated as an S corporation by the IRS for tax purposes is an option you may not know you have.
Thus, instead of forming a business as a corporation, you can set it up as an LLC and have it taxed as a corporation instead of as a sole proprietorship or partnership.
- Single-owner LLC: taxed as a sole proprietorship, using Schedule C of your tax return
- Multi-owner LLC: taxed like a partnership, using Form 1065, with each member filing Schedule K-1
Many LLCs choose to be taxed as a corporation to save on taxes by avoiding double taxation.
One major advantage of electing to be taxed as a corporation is its benefit to the owner. Owners don’t have to take all the business income on their tax returns.
Should You Form an LLC for Your Business?
Forming your business as an LLC and electing treatment as an S corp can give you the best of both worlds. With this, you’ll enjoy the ease of forming and running the business and take advantage of the tax opportunities of an S corporation.
Here are matters worth considering:
- From a legal perspective, your business will be formed as an LLC. This gives you lesser complexities when it comes to administration, and more flexibility when it comes to structure and profit distribution
- From a tax viewpoint, your business will be taxed as an S corporation. This provides opportunities when it comes to tax planning to minimize the overall tax liability. It also gives you an advantage in terms of avoiding double taxation.
The Bottom Line
There is no “one size fits all” answer when it comes to the business entity type you will choose.
When choosing a business structure for your start-up, you need to consider your startup’s financial goals, needs, risk, and ability to grow. Aside from that, you have to consider all the pros and cons of forms of different business entities, your local, state, and federal laws, and how these structures are taxed.
It’s best to seek professional advice from a CPA or a tax attorney to guide you in understanding your options.
Talk to your professional advisor today.