The pros and cons of an LLC
A limited liability business (or LLC) is a common structure for small and startup businesses. The members of the LLC own the business. Although the main effects of a business's structure are taxation and legal liability, they can also have an impact on the core of the business and its day-to-day operations. These are the main factors that influence a business's legal and formation structure:
- Obligation to complete initial paperwork
- Formality of the business structure
- Ownership structure based on membership
- There are many options for raising money
- Taxation for businesses
- Personal liability in the case of a business-related loss
To better understand the formation options and their implications for liability and tax burden, the best thing to do is to visit the Secretary of State website. You can also file your formation here and pay the state-specific filing fees.
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Overview: The Pros and Cons Of An LLC
This article will discuss the positives and negatives to using an LLC for business formation. Before we get into the pros, take a look at the table below.
Pros of an LLC | Cons of an LLC | |
|---|---|---|
Formation | Easy Filing Simple, unilateral filing of paperwork | Annual Fees and Maintenance An LLC can be associated with annual reports and fees up to hundreds of dollars |
Membership and Management | Membership Flexibility and Ownership Unlimited owners and members of all types, as well as management options | Flexibility of Member Turnover Changes in members of an LLC can lead to rigid paperwork requirements and other issues. |
Capital Access | Easy Money Distribution Owners/Members have the option to "draw" from the company profit account, rather than take salaries. | Limited Investment Options It is unlikely that the business will attract outside investment. |
Taxation | Pass-Through taxation Taxes simplified and (potentially!) lower | Miscellaneous Taxes Tax Burden Pass-through taxation does not necessarily mean less taxes |
Formality | Credibility The formal business structure gives credibility to your business | |
Legal Liability | Personal Liability In the event of a business loss, personal assets of both the owner and member are protected |
Pros of an LLC
An LLC is an affordable, low-risk, safe, and cost-effective form of business organization for small businesses. This is especially true for those who are just starting out in self-employment. Here are some of the benefits of forming an LLC.
Filing is easy
The paperwork required to file an LLC is minimal. This paperwork can be done online in under an hour depending on the level of your Secretary of State website. Although the filing fees can vary by state (ranging from $40 in Kentucky to an astounding $500 in Massachusetts), the process is similar and many state websites provide instructions online.
These are the steps for setting up an LLC:
1. 1. Determine your filing status
The state where you are filing is likely where you currently live, and where you plan to do business. Every state has its own filing process and fees. A visit to the website of your Secretary should be ground zero.
2. 2.
If you don't have one, check out our name generator tool to learn how to create one.
3. Select a registered agent
This simply refers to the process of appointing an individual to receive regulatory and legal documentation on behalf the business. The registered agent serves as the official and formal contact for the company. While some business owners choose to do this, it is worth considering a fee-based service for registered agents to provide additional protection, formality and compliance to the business model.
It is more affordable than you think. The added risk-reduction could pay off over time, or at least for the first one year. These are some of the most popular Registered Agent services sites:
- ZenBusiness (99$ per year).
- Northwest Registered Agent (125 USD per annum)
- Incfile (119/year)
4. 4. Prepare your operating agreement
A operating agreement is just as important as a business plan, but it is not required every time. Although some states require it, it is a good idea to clearly define the roles of all members upfront. This is particularly important if the LLC has multiple owners/members. Defining roles becomes crucial.
5. Register your LLC with your state
The articles of organization are the most important part of filing your LLC with your state. They outline the essential business components such as the name of the company, its location and purpose, identification of the registered agents, and management structure.
6. 6.
The tax identification number (TIN) or business employer identification number (EIN), is the business's number for taxation. If the owners of a business plan to hire employees or open business bank accounts, this is a mandatory filing.
7. 7.Open a bank account for your business
This is a good thing to do, but not a necessity. It is particularly important for LLCs that have separate owners and business finances.
Related Best Small Business Accounts
You may prefer a more user-friendly, guided process. Instead, you can go directly to Infile. This expedited site will help your LLC get up and running faster.
Credibility
A state-issued stamp of approval stamping approval on a business stating it is a formal entity is an acceptable way to go. An LLC, in addition to being able to register any business structure through state registration, is more formalized than a sole proprietorship or partnership. An LLC offers greater credibility and protections than a sole proprietorship or partnership. However, there are additional obligations, formalities and paperwork. Some businesses choose to transition from sole proprietorship into an LLC as it offers tax benefits and additional protections.
Separation of owners and the business is another hallmark of formal vs. informal formation. The owners of sole proprietorships or partnerships are not considered separate from business operations and liabilities. However, LLC owners and members of corporations and partnerships are treated as separate entities. This is partly why personal assets can be protected in the event of financial losses in the business. This formality provides additional protection and limits personal liability.
Flexibility in Membership, Ownership, and Oversight
Multi-member LLCs offer more benefits, including unlimited ownership and flexible management. An LLC's "members," also known as owners, can include individuals, corporations, trusts, partnerships, corporations, trusts, or other LLCs. You can also have multiple single-member LLCs. These members can run the business however they wish, whether owners are involved or hire management. These two options are called Member-Managed or Manager-Managed. Corporations, on the other hand, are managed and overseen by officers or boards, not owners. Therefore, the LLC offers a simplified and more efficient oversight structure.
Many states require that LLCs indicate whether they are Member-Managed or Manage-Managed. Otherwise, the LLC will default to MemberManaged. This choice should be made in advance and documented in the operating agreement.
Distribution of Easy Cash
An LLC's major benefit is its ability to distribute profit to members. This is not in the form salary, but in the form "profit distributions" and "draw of funds" from the profit accounts. This is because draws and profits are not subject to tax. (More on that later). Instead, your company profit is reported on your personal tax returns at year's end.
Pass-Through Taxation
The benefit of "Pass-Through taxation" is also mentioned. This means that the income and profit of a business "passes through to the owner's personal tax return." This eliminates corporate income tax, as well as the possibility of double taxation. This can help LLC members save substantial taxes in the long-term. makes taxation easier by being taxed once on the personal tax return that one would file anyway.
Potential tax deductions are another tax-related benefit for LLCs. One example of this deduction is the Qualified Income (QBI), benefit. This allows LLC owners to deduct 20% from their business' net income in addition to standard expenses.
Limited Personal Liability
This formation's name explains the liability of its owners. Your personal assets, such as your home, vehicle, savings accounts and heirlooms are protected from liability in the event of business losses. This protection could mean the difference between losing your business or completely losing it. This protection is often enough for small business owners looking to reduce personal risk and protect valuable assets.
Many things can be interpreted as financial loss or business liabilities. These are just a few of the many reasons why an LLC would be a valuable asset to protect members' personal assets.
- Lawsuit
- Bankruptcy
- Failure of a business
- Unpaid debts
- Unmet obligations
Limited liability does not guarantee failure. There are some exceptions which make owners and members more vulnerable to business losses.
- Personal guarantee of member to get a business loan or other debt
- Member commits tax and/or fraud
- Member directly and personally damages an individual
- Intentionally commits a crime against an LLC member or an individual
Cons of an LLC
This sounds appealing. It offers flexibility, ease of filing, and limited liability. While there are many benefits to starting an LLC, there are also some downsides. These include the fact that it can be difficult for people to file an LLC. Before you start your LLC, consider the following:
Maintenance and paperwork
In order to maintain an LLC's good standing, some states require annual reports. There may be fees (or depending upon the state), reports and detailed paperwork. In order to avoid personal liability due to pass-through taxation, owners and members must maintain separate financial records.
Flexibility in Member Turnover
An LLC can be a solid and low-risk choice for business formation. However, it can also present a delicate balance. The LLC may need to be re-filed if the ownership structure or membership is changed. If a member leaves or joins an LLC, the LLC could be required to dissolve and reform.
This change will most likely require amendments to operating agreements and articles of organisation, filing Articles of Amendment to your state registration agency and amending paperwork submissions to IRS. If there were to be a change of members in your LLC, you might first consult an attorney in order to fully understand the implications in your area and unique circumstances.
Limited Investment Options
There are many financing options available to LLCs, including general equity and debt capital.
Equity Financing Most equity funding for LLCs is from injection capital provided by members. LLCs can raise equity capital by new members either as a fee for admission or as part of intermittent contributions in return for a share in company.
Debt Finance Many LLCs are funded initially or continuously by loans. This is a form of debt financing. These loans can be in the form personal loans or informal loans as well as bank loans, lines credit or grants.
Crowdfunding and Fundraising - An LLC may also use private fundraising activities, peer fundraising and online crowdfunding sites to help fund the startup or scaling up.
Outside Investors (Angel or Private) Because LLCs cannot issue shares like corporations, the only way you can invest in an LLC's stock is to become a contributor member and coowner. Outside investors view LLCs as more risky investments that a corporation. While more members may result in more capital injection for them, it could also lead to a smaller profit pool.
Misaligned Taxes and Misaligned Burden
Even though pass-through taxation is preferred, there are additional taxes that you should consider when forming an LLC. The following are some of these:
- Self-Employment Taxes
- Franchise taxes (where applicable).
- K1 forms are for individuals to report share of ownership or tax liability.
- Employment taxes
- Personal and corporate taxes
- Excise Taxes
Owners and members don't take salary but instead draw on profits as a form of profit-sharing, as explained in easy cash distribution. Members are taxed on the profits they receive, regardless of whether payments have been made to them.
Guaranteed payments are the exception to this rule. These payments are made to LLC members for capital use or services rendered. This ensures that LLC members are financially stable and fairly compensated, regardless of whether or not the LLC is profitable. These payments are not proportional to the ownership shares of the corresponding members. This can cause a skew in their income according the IRS, which may lead to a disproportionate (too low or too high) taxation.
Bottom line
The cons of setting up an LLC would outweigh the benefits. It wouldn't be the most popular business filing type in the United States. Recent years have seen an increase in LLC business filings to almost 2.7 million in the US. This is more than any other entity type for the 16th consecutive season. Consider your circumstances when evaluating different business structures. To determine the best business structure for you, consider your risks and liabilities, as well as your member structure and taxation. You can also consider other business structures such as sole proprietorship, partnership and corporation.
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