Business Owners: Should You Organize as an LLC?
There’s a certain amount of risk that comes with owning a business. Accidents can happen no matter how well a company is run, and a lawsuit could prove to be devastating if the business is found to be at fault.
A limited liability company (LLC) is a business structure that offers many of the same legal protections as a corporation. Establishing an LLC creates a separate legal entity to help shield a business owner’s personal assets from lawsuits brought against the firm by customers or employees. In theory, the financial exposure of the owners (members) would be limited to their stake in the company, but exceptions may include any business debt they personally guarantee or misdeeds (such as fraud) they carry out. Just like a corporation, an LLC can lose its limited liability if the owner does not follow formalities that continue to exhibit the separate existence of the business — which is known as “piercing the veil.”
Beyond liability protection, there are some additional benefits associated with LLCs.
Tax efficiency. An LLC is a pass-through entity for tax purposes, so a firm may pass any profits and losses to the owners, who report them on their personal tax returns. Members can elect whether the LLC should be taxed as a sole proprietorship, a partnership, an S corporation, or a C corporation, provided that it qualifies for the particular tax treatment.
Credibility. Starting an LLC may help a new business appear more professional than it would if it were operated as a sole proprietorship or partnership.
Simplicity. In most states, an LLC is easier to form than a corporation, and there may be fewer rules and compliance requirements associated with operating an LLC. The management structure is less formal, so a board of directors and annual meetings are not usually required.
Flexibility. Being registered as an LLC may facilitate growth because it’s possible to add an unlimited number of owners and/or investors to the business, and ownership stakes may be transferred easily from one member to another. LLCs may also be owned by another business.
Partners Prefer LLCs
Percentage of sole proprietorships and partnerships that indicated LLC status on tax returns
Source: Internal Revenue Service, 2022 (most recent data from 2019)
The specific rules for forming an LLC vary by state, as do some of the tax rules and benefits. A written operating agreement that outlines the division of ownership, labor, and profits is a common requirement. It generally costs more to form and maintain an LLC than it does to operate as a sole proprietor or general partnership, but for many businesses the benefits may outweigh the costs.