A limited liability company (LLC) is a type of business structure that allows its owners to protect themselves from personal financial losses. While LLCs have many advantages, they also have certain disadvantages. This article will explore the advantages and disadvantages of LLCs, an overview of the pros and cons of LLCs, as well as tips for weighing the benefits and risks associated with this type of business entity.
First, you must file Articles of Organization with the Secretary of State in your state. You can then draft and file an LLC operating agreement (and/or bylaws) to set forth the rules that govern how corporate decisions are made among members. Next, you will need a registered agent for the service of the process – though this is not something that all states require from entrepreneurs setting up their business.
The following are summarized forms for the whole process:
- You need to file Articles of Organization with the Secretary of State.
- You will need to pay a filing fee and obtain a certificate of registration.
- You will also need to appoint a registered agent and keep current on their fees.
- Once you have completed all of the requirements, you can start operating your business.
What types of businesses are best suited for LLC?
C corporations, proprietorships, and periodic tenancies (farming tenancy) are the only non-default LLC types that can be created in most states. Professional service businesses organised as limited liability companies include lawyers and other professional services such as accountants or architects.
Why choose an LLC? Liability protection: An individual owner of a traditional business arrangement has unlimited personal liability for all mistakes made while performing managerial functions – this goes against the law.
Pros of LLCs
Multiple pros are concerned when it comes to structuring your business as an LLC. Avoid ‘double taxation minimum franchise tax – no annual reporting is required (for businesses in California, each LLC member’s share of profits will be subject to a state Franchise Tax) An elephant doesn’t pay taxes! Professional Services should consider an operating agreement.
Pros of S-corps and limited liabilities for managers:
The Pros for a single owner or manager who owns the entire business are all about cash flow, profits, and decision making. Since owners use one common bank account to pay salaries/expenses and distribute profits, there is always financial motivation to make money stay on top (close) instead of off in a pile somewhere – so this increases productivity!
Superior hedge for stakeholders:
Members’ capital contributions are distributed on a pro-rata basis to each LLC member’s share of the profits. This means that each member has an equal ownership stake in the business and shares in the profits equally. Payroll is shared, thus reducing taxes because payroll takes personal deductions from profit sharing formulas and since you don’t have “two” salaries instead of one! (the employee gets to take a deduction for his salary, and another as he treats it).
Legacy system and Modernization:
As far as initial paperwork is concerned for the registration, it is comparatively easy and simple enough to get into without any complexes. Though there a wide range of variations has existed from state to state in terms of fees and taxes. However, it is always considered a good idea to hire a relevant agent or accountant to perform the activity following the governance and laws of regulatory authorities because routine requirements come up on the annual basis.
You may very well ask; why should you choose to be an LLC? If the owners only own capital and salaries are less compared to S-corporations, what then is the benefit? Well! The participants need not worry about distributions or taxes because members will get their fair share in return for each portion of capital contributed by them (which may also sound like a huge problem).
Taxation on Profit sharing:
Contributing to an LLC can yield a benefit of confidential tax affairs and privacy. A business owner would know that no personal taxes are associated with the contributions made by him. Someone may not suspect, if he is only free from withholding income on his paycheck because he receives less than enough earnings throughout one year or due to some other reason such payout does not exist in all cases.
After calculating the figures for net income, it is not directly declared to the IRS (Internal Revenue Services), but it has to pass through the tax return of business owners. For example: To determine their liabilities as an individual the business has to calculate net income after excluding deductible expenses (Sec 199A). Then each person has to file their return statement according to the net income. For example, the Sole proprietor will file a return against the calculated tax on the owner’s net income. In an S corporation and partnership, the tax calculation will be determined according to the shared profit percentage.
- The majority of the businesses are reported as Pass-through businesses.
- On a federal level, it considers the top marginal rate of 44.6%.
- Over the past 29+ years, a significant increase has been observed in pass-through businesses.
Cons of LLCs
Consider these possibilities of drawbacks before Opt LLC for a business.
It has been observed that LLCs cost more to the formation than a partnership and sole proprietorship, due to applicable charges for initial formation and ongoing annual fees for reporting by states. And all the charges can greatly vary by state. The most expensive state to form an LLC in is Massachusetts, the filing fee of $520 and an annual renewal fee of another $500.
- If your LLC submits a form to the IRS, which is taxed as an S corporation, you and other owners working for that company will only be subject to social security tax on actual profit, not on all the pre-tax profits of the company.
- If your LLC is registered as a partnership then, the government will consider every single member of a business as self-employed. That means all the members are liable to pay their Medicare and social security taxes as per the declared tax rates by regulatory authorities, based on net income. Which is known as “Self-employment taxes”.
- This disadvantage was most pronounced for owners who earned an average amount of $98,000 for the 2007 tax year.
A consequence of changing members:
In multiple states, if a member gets withdrawn, goes bankrupt, or dies. Then LLC has to be dissolved as per the declared regulation. And rest of the members are responsible to take all the necessary legal and financial measures to be taken for the termination of the LLC, however, they still can continue to run the business together but they’ll have to register a new LLC and start from scratch.
LLC is often more challenging to transfer than a company. In the case of a company, the company can sell its shares to increase ownership, and stakeholders can sell their stocks to someone else unless there is an opposite stockholders agreement. Normally, in the case of LLC, all members are required to approve the addition of new members or changes in the ownership ratio of existing members.
Owners segregate profit immediately:
As per the business structure of C corporation, the company does not need to distribute its profit on an immediate basis among the shareholders, ultimately which means shareholders are not always taxed on C corporation’s profit.
Employees who engage with C corporation are not required to pay taxes on fringe benefits i.e. Medical insurance, home allowances, medical reimbursement plans, etc. On the other hand, LLC members are required to report annual payable taxes against these benefits.
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