When you're starting a new business, you have a lot of choices. You can follow the lead of many large successful companies and form a corporation. But you may also have heard that limited liability companies are good for smaller businesses.
For those thinking of starting an LLC, here are six of the main LLC benefits.
1. Limited personal liability
If your business is a sole proprietorship or a partnership, you and your business are legally the same "person." Your business debts are also your personal debts. And if your business partner or employee is accused of negligence, your personal assets might be at risk.
An LLC limits this personal liability because an LLC is legally separate from its owners.
LLCs are responsible for their own debts and obligations, and although you can lose the money you have invested in the company, personal assets such as your home and bank account generally can't be used to collect on business debts. Your personal assets are also generally protected if an employee, business partner, or the business itself is sued for negligence.
2. Less paperwork
Corporations also offer limited liability, but they have to observe certain requirements that may not be well suited to a small, informally run business. For instance, corporations typically must hold annual shareholder meetings, make annual reports and pay annual fees to the state. They also tend to have substantial recordkeeping requirements.
In contrast, LLCs don't have to hold annual meetings and usually are not required to keep extensive records. In many states, LLCs do not need to file annual reports.
3. Tax advantages of an LLC
LLCs get the best of all worlds when it comes to taxation. LLCs don't have their own federal tax classification, but instead adopt the tax status of sole proprietorships, partnerships, S corporations or C corporations.
The Internal Revenue Service automatically classifies LLCs as either partnerships or sole proprietorships, depending on whether they have one owner or more than one owner. This means that LLCs can always take advantage of "pass-through" taxation in which the LLC does not pay any LLC taxes or corporate taxes. Instead, the LLC's income and expenses pass through to the owners' personal tax returns, and the owners pay personal income tax on any profits.
In contrast, traditional C corporations are taxed twice on distributions to shareholders: once at the corporate level and once at the individual level. S corporations avoid double taxation and receive pass-through tax treatment, but not all corporations are eligible.
4. Ownership flexibility
S corporations enjoy pass-through taxation, but they have several ownership restrictions. For example, they can't have more than 100 shareholders, can't include foreign shareholders and can't have shareholders that are corporations. LLCs provide pass-through taxation without any restrictions on the number and type of owners they can have.
5. Management flexibility
Corporations have a fixed management structure that consists of a board of directors that oversees company policies and officers who run the day-to-day business. Owners, also known as shareholders, must meet every year to elect directors and conduct other company business.
LLCs don't have to use this formal structure, and an LLC's owners have more choices about the way they run the business and make decisions.
6. Flexible profit distributions
LLCs have flexibility in the way they distribute profits to their owners, and they aren't required to distribute them equally or according to ownership percentages. For example, two people may have equal interests in an LLC, but they may agree that one of them will receive a greater share of the profits because he or she contributed more money or labor in the business's startup phase.
Corporations, on the other hand, must distribute profits to shareholders according to the number and types of shares they hold.
An LLC's simple and adaptable business structure is perfect for many small businesses. While both corporations and LLCs offer their owners limited personal liability, owners of an LLC can also take advantage of LLC tax benefits, management flexibility, and minimal recordkeeping and reporting requirements.
Find out more about Starting a Business