A limited liability company (LLC) is one of the most common types of business structure used by entities throughout the U.S. LLCs combine certain aspects of partnerships and corporations, providing owners with the tax benefits of a partnership and the liability protection of a corporation. However, with these benefits come certain disadvantages that business owners should consider before determining which business formation is best for their particular situation.
Forming an LLC is Relatively Simple
One major benefit of choosing to organize your business as an LLC is that forming it is relatively simple and inexpensive.
Before you can officially form your company, you will need to choose a name. The requirements and restrictions for an LLC’s name vary by state, but most require you to choose a unique name that includes some indication that the company is an LLC. Usually, owners include the words “Limited Company” or “LLC” at the end of the name. Some states keep the database of registered names online, allowing you to check the availability of the name you want.
Once the name is finalized, you can file the articles of organization with your state’s Secretary of State or appropriate agency. This simple document is what actually creates your business. The articles of organization usually must include the name of the business, its address and other contact information, the identity of the owners, and other basic information about the business. There is likely a fee required to file the articles of organization.
In most states, filing the articles of organization is all that is required to form an LLC. However, there may be additional requirements in your state, and there are optional documents that may help the business run more smoothly in the future. For example, LLCs with more than one owner may benefit from an operating agreement that outlines the owners’ roles and rights, including how profits and losses are split. You may also need to apply for any required licenses or permits.
Owners’ Personal Liability is Limited
The benefits to structuring a business as an LLC are what make them so attractive. As the name implies, LLCs offer their owners some protection from lawsuits and creditors. As discussed above, they are generally easy to form, and continuing their operation, as long as the owners stay with the business, is also usually inexpensive. LLCs provide their owners lots of freedom when it comes to spending money, splitting profits, and hiring employees.
Another benefit is that LLCs are not considered separate taxable entities, unlike corporations. Owners simply pay taxes for the LLC’s income on their personal income tax returns.
Owners Pay Self-Employment Taxes
There are two notable disadvantages to choosing an LLC. The first is that in most states, if the owners of the company change, the LLC is automatically dissolved. The new or remaining owners must form the business all over again. Although this is a straightforward process, it can be a hassle if the owners of a company change frequently.
Furthermore, although the owners of an LLC enjoy the benefit of paying taxes on their personal returns, they must pay the self-employment tax, which includes contributions to Medicare and Social Security, on the entire net income of the business. This may end up costing more in taxes than other organizations. It is possible to avoid this disadvantage by organizing your LLC as an S-Corporation for tax purposes. Owners of an S-Corporation pay employment taxes only on their wages, which in many cases works out in their favor.