You don’t need an LLC, but you might want one.
An LLC is a limited liability company, a popular type of business structure that limits the liability of the business owner or owners, called members. If someone sues your company, has a lien or judgment against your company, that person or entity cannot attempt to take your personal assets, only business assets, when you’re structured as an LLC.
Starting a Business Without a Formal Structure
You can start your own business without creating a formal business entity. When you do this, your business will default to a sole proprietorship if you are the only owner. If you have at least one other owner, your business will default to a general partnership.
Not creating a formal business structure has benefits. It’s cheaper because you don’t have to file any setup paperwork or annual reports. It’s easier because you simply start operating your business. It’s safer if you’re not sure your business concept will work. Unwinding an LLC or other formal business structure involves lots of paperwork and steep costs.
Without a formal business structure, however, you leave your personal assets at risk. If your business is sued, if you’ve taken out loans, or if your co-owners engage in wrongdoing, you could be personally liable and your personal assets could be seized to pay off a debt.
How an LLC Works for Small Businesses
An LLC not only gives your small business more credibility by being a formal business structure, it also helps protect your personal assets in the event of a lawsuit or business lien. When set up correctly, an LLC makes your personal bank accounts, home, and other valuable assets off limits.
Whether you run a freelance creative business, rental property company, or any startup, an LLC may be the right structure for your business.
Member Protections
An LLC gives members protection by limiting their personal liability. Business debts, liens, and lawsuit judgments can be collected against the business assets only. Any person or entity holding a debt, lien, or judgment cannot pursue the personal assets of LLC members in most cases.
Limits to LLC Protections
Your personal assets may be at risk in a lawsuit if you acted negligently or illegally. An LLC will not provide protection if you personally guarantee a business loan. If you mingle your LLC assets and personal assets, that could also expose you to personal liability, even if the wrongdoing is only business-related.
Tax Treatment of an LLC
An LLC defaults to a pass-through entity for federal tax purposes. Instead of paying company taxes, an LLC’s members pay tax on their share of profits as part of their personal tax filing. So, if you are a single-member LLC, the entire annual profits from your LLC would be reported on your personal tax return.
However, an LLC’s members can elect to be taxed as a C-corporation or an S-corporation. To make this election, the Internal Revenue Service requires you to submit documentation.
Choosing to be taxed as a C-corp, your LLC will pay corporate tax at the federal level and any corporate taxes owed to your state and city. As a member of the LLC, you only pay taxes on the income you receive.
Choosing to be taxed as an S-corp is similar to the default method of pass-through taxation. By dividing profits between income and dividends, an S-corp can help you avoid double taxation. However, an S-corp has high administrative costs for record keeping and meeting requirements.
Simplicity
While it costs money to set up an LLC and file annual reports, an LLC is the simplest formal business structure to form and operate. You do not need officers or a board of directors, and there are no meeting requirements. You simply create your operating agreement, pay the filing fees, and file annual reports with your Secretary of State.
Flexibility
The flexibility an LLC provides often scares investors away. But if you’re not looking for investors, the versatility of an LLC has numerous advantages.
There are no limits as to how many members you can have in your LLC. You can choose to have your LLC managed by all members, a select few, or just one. You also get to decide how you want your LLC taxed.
Credibility
An LLC gives your small business credibility. Your customers and clients will be more inclined to trust your business if they see that you have a formal business structure. You also have an official business name which receives legal protection, so no one else in your state can use the same or substantially similar business name for their company.
Small Businesses that Benefit Most From an LLC
Knowing what an LLC is, how to form one, and how it can benefit your business will help you decide if it’s the right business structure for your small business. You may want to consider an LLC if you have co-owners or employees, or intend to have them soon. You will be protected if the other members or employees violate laws or commit other wrongdoing.
Businesses that have multiple assets could also benefit from an LLC structure. LLCs provide protection for people who own several rental properties, for example, if something goes wrong with one, protecting the other properties and the member’s personal assets.
Disadvantages
The biggest disadvantage to an LLC is the cost. As a sole proprietor or a general partnership, there are no costs to set up and operate your business. With an LLC, however, you have initial filing fees, attorneys fees to draft your operating agreement, and annual fees to your state.
Depending on your industry, some states require a professional LLC. These business entities are designed for licensed professionals like doctors, lawyers, and engineers. If your business operates in an industry that requires licensure, then all members of your professional LLC must be licensed.
Bottom Line
It’s almost never a bad idea to form your company under a formal business structure. An LLC may be a good option if you’re looking to limit your personal liability. Business insurance is important for every company, but owners of a small business benefit from additional protection provided by an LLC.
