LLCs have become the preferred business entity in the U.S. Here’s why.
Starting a business has never been more convenient and often only requires a laptop, a good internet connection and a functional phone. Venturing on your own can be daunting, but also exciting. Not only will you create more opportunities for yourself, but having your own business affords you the opportunity to give back to your community in the form of the products and services you offer, and in time, contribute to the overall success of the economy.
One of the biggest decisions you will have to make will be determining the format of your business. With so many options, how do you know which legal structure is best for your business? One option favored by startups and business owners is the LLC structure. Although it is fairly new (the first LLC company was formed in Wyoming in 1977), LLCs have mushroomed across the U.S.
What is an LLC?
A limited liability company (LLC) is a legal form of business, recognized on both federal and state levels, that allows owners (called members) to limit their personal liabilities while enjoying the tax and flexibility benefits of a partnership ( a business entity of two or more individuals). Under this structure, members are shielded from personal liability for the debts of the business if it cannot be proven that they acted in an illegal manner in carrying out the activities of the business. In addition to personal liability protection, there are many other reasons why startups use an LLC structure. Here are 7 of the best.
Why are LLCs popular?
The LLC format is less complicated and easier to form than corporations who have a range of formalities that corporate managers must observe. For example, unlike corporations LLCs have less paperwork and expenses, and don’t have to abide by red tape like holding regular shareholders’ meetings or keeping minutes. This gives you more flexibility in the way you run your business and make decisions.
The “owners” of an LLC are called “members”, while the persons who are managing the company are called “managers”. An LLC can have one member or an unlimited number of members. However, if an LLC has just one owner, it will be taxed as a sole proprietorship (single-owned business).
LLCs can opt to be managed by:
- its members (member-managed), which allow all owners to share in the business’ daily decision-making, or by
- managers, who can either be members or outsiders (manager-managed). This is useful, if for example, you need to employ an outsider in the event the company’s members do not have the necessary business skills or experience.
In addition, members may conduct business according to the rules tailored to meet their needs as specified in the LLC Operating Agreement. For example, how profits will be distributed or how ownership will be devided.
Flexible tax treatments
LLCs are often treated as “disregarded entities” and can choose to be taxed as a:
- sole proprietorship (single-owned entity where the owner is legally responsible for its debts),
- partnership (a business association of two or more individuals) or
- S Corporation ( this is not a type of business entity, but an IRS classification where owners pay income tax and self-employment tax on a predetermined salary).
You avoid double taxation
One of the significant benefits of LLCs is the avoidance of double-taxation.
Because LLCs can choose how to be taxed, they have the option of being treated as a pass-through entity, which means members do not have to file a corporate tax return. Instead, members report their share of profit and loss on their individual tax returns, thereby preventing the business paying taxes and the owners paying taxes (double taxation). This differs from corporate taxation, in which the profits are taxed at both the corporate level and on the owners’ tax returns.
For more information on taxation for LLCs go to the IRS website.
Your entity should support the possibility for growth and change, not hold it back from its potential. What do you do when your business grows to an extent that an LLC is no longer the appropriate form? Easy. Small companies typically start out as LLCs, outgrow the form and then transfer the assets to a corporation with the same owners as the LLC. We suggest acquiring legal expertise when converting your business to a bigger structure.
An LLC, as opposed to a sole proprietorship, enhances the credibility of your business. Having the letters LLC or phrase “Limited Liability Company” in your business makes it more appealing to banks and creditors for loans.
You choose where to form your LLC
Most startups choose the state where they are based to form their business. However, the LLC formation can be set up in any state, regardless of whether you plan on doing business there or not. Keep in mind that each state has different laws, and should you decide to form your business in another state, you will have to register it as a “foreign LLC”, which can potentially increase your formation and administration costs.
LLC vs. Corporation
Often entrepreneurs are undecided between choosing the Corporation or a Limited Liability Company format for their business. Although both entities offer personal liability protection, each form has its own benefits and drawbacks. Here are the main differences between LLCs and Corporations:
An LLC is owned by one or more individuals (members), and a corporation is owned by its shareholders.
LLCs are taxed as a pass-through entity by default. This means that the profits of the business are “passed through” to the members, which means LLCs are not subject to double taxation.
Corporations pay tax on their profits and tax on dividends the business distributes to its shareholders. This is referred to as double taxation.
An LLC has a flexible management structure.
A corporation’s management structure is much stricter. A corporation must have a formal structure, with a board of directors handling the management responsibilities of generating profits for the shareholders.
LLCs have the freedom to choose how to distribute ownership irrespective of a member’s financial contribution to the LLC.
Corporations can issue shares or stock to its owners (shareholders).
Before choosing the format for your business, it’s crucial that you do due diligence and read more to enable you to make an informed decision.