Do I even need an LLC?

An LLC is a business structure that helps protect business owners from being held personally responsible for the entity’s financial obligations.

Many small businesses are organized as LLCs because an LLC offers many of the same liability protections as a corporation but with a less rigid structure and fewer administrative requirements.

But not everyone needs an LLC. Some businesses will do just fine as sole proprietorships, while others should form a corporation instead. Here are some basics to help you decide what's right for you.

What will an LLC do for me? 

Forming an LLC gives your business its own legal identity. In the eyes of the law, it's a separate “person" that can own money and property, have a bank account, make agreements, sue people, and be sued.

Because of this, your business' creditors generally can't go after any money or assets that aren't owned by the LLC. Your home, bank account, and other personal assets are protected. By contrast, if you operate a sole proprietorship or general partnership, you and the business aren't legally separate, and everything you own is at risk.

LLCs also have other advantages:

• Limited liability protection. If you have business partners or employees, an LLC protects you from personal liability for your co-owners' or employees' actions.
• Flexibility in management. An LLC gives you a structure for operating your business, including making decisions, dividing profits and losses, and dealing with new or departing owners.
• Pass-through taxation. An LLC offers taxation options. Most LLCs are taxed as a sole proprietorship or partnership, but LLCs can also choose S corporation or C corporation taxation.
• Independence. If you have an LLC, you don’t need to explain your decisions to shareholders like you would with a corporation. If you have a multimember LLC, you can outline the scope of each member’s (owner’s) duties in your operating agreement to make sure everyone is on the same page. 
• Credibility. Forming an LLC can help enhance your business’ credibility and build trust with potential customers.

What an LLC can't do and disadvantages

While an LLC remains a popular entity choice due to the personal liability protection and tax advantages it can provide, there can be some disadvantages to an LLC when compared to simpler business structures (such as a sole proprietorship), including cost and complexity. 

Here are a few potential disadvantages to keep in mind when deciding whether an LLC is right for you. 

Investors often favor corporations

Unlike a corporation, an LLC can't issue stock, and this complicates matters if you want to take on investors. Many investors prefer corporations over LLCs.

State restrictions may apply to certain professions

If you are a licensed professional such as a doctor, lawyer, accountant, architect, or engineer, your state may not allow you to form an LLC.

Liability protection can be limited

There are also limits to an LLC's liability protection. You will still be personally liable if someone sues you for your own negligence or wrongdoing—even if the accusations are related to your business. An LLC does not protect your assets if you personally guarantee a contract or loan. And it won't protect the business itself from losing everything in a fire, flood, lawsuit, or economic downturn. 

LLC owners may also face the risk of so-called "alter ego" liability, which, under certain circumstances, can make them personally liable for their business debts and obligations. You can help mitigate this risk by making sure to observe the formalities of operating an LLC, such as by holding board meetings, keeping business bank accounts separate from personal accounts, and using separate office space, among other things.

Costs can add up

The expenses involved in setting up and maintaining an LLC can include state fees and annual reports and vary by state. 

For example, Texas doesn’t charge an annual renewal fee, but the state filing fee for a Texas LLC is $300, while the cost of an LLC in Florida includes a $100 filing fee and a $138.75 annual LLC fee. 

LLC members may face self-employment taxes

Self-employment tax (SE tax) consists of Social Security and Medicare taxes. Employers calculate SE tax for most employees, but LLC members may have to pay SE tax on their share of profits. The SE tax rate is 15.3% (12.4% for Social Security and 2.9% for Medicare).

More complexity compared to simpler structures

An LLC can have increased administrative responsibilities compared to businesses structured as sole proprietorships or general partnerships. 

Because of the limitations listed above, an LLC should ideally function as part of a comprehensive business protection strategy that includes using well-written contracts, protecting your intellectual property, complying with federal, state, and local regulations, and obtaining business insurance. Insurance can help protect you and your business against the unexpected, while an LLC helps shield your personal assets from your business's creditors.

If you are a licensed professional such as a doctor, lawyer, accountant, architect, or engineer, your state may not allow you to form an LLC.

Who benefits the most from an LLC?

Your business is most likely to benefit from being an LLC if either of these is true:

• You have co-owners or employees. Without an LLC or other business entity, your personal assets are at risk if your business is sued for something a co-owner or employee does. An LLC operating agreement also helps to avoid conflict and misunderstandings between you and your business partners.
• Your business has significant risks. Some types of businesses are at high risk for failure. Others have both financial and liability risks. For example, multiple LLCs are a common strategy for rental property owners to ensure that financial problems with one rental don't jeopardize the others—or your own life savings.

Who can skip LLC formation?

Forming a business entity like an LLC or corporation is almost never a bad idea, but it isn't always an absolute necessity for a solo business owner.

To decide whether you need an LLC, consider:

• Whether you plan to have partners, employees, or outside investors.
• Whether you have significant contracts or creditors that might lead to financial problems or lawsuits. For example, an unpaid creditor or court judgment could easily cause personal financial trouble if you own commercial real estate, but that's much less likely for most consultants and Etsy sellers.
• Whether you want to have the additional expenses and obligations of forming and running an LLC. There's a fee to form an LLC, and in most states, you must file annual reports and pay an annual fee. You will also need a separate LLC bank account.

If you're trying to limit your business liability, make sure you have adequate business insurance. If you have business partners, employees, or significant risks, an LLC can provide another important layer of protection.

At what point do I need an LLC? 

Whether you’re a sole proprietor thinking about starting an LLC or have a more complex business structure that you want to convert to an LLC, there are a few things you should consider—including profitability, risk exposure, and whether you will have employees—when deciding when to establish an LLC for your business.

Profitability

Many companies decide to get an LLC once they start generating steady profits, but it's important to weigh the costs of creating an LLC against your business’ income. If your business has only made a small amount of money or is in a low-risk industry, you might consider using the money it would cost to set up an LLC on revenue-generating activities instead. 

However, businesses of all sizes and income levels can be subject to legal action, and as long as you can afford it, setting up an LLC can help ensure your personal assets are protected—regardless of your income level. 

Risk exposure

For businesses in industries that involve significant risk—such as construction, real estate, and healthcare—an LLC can serve to protect your personal assets. Even if you run a low-risk business, the potential for lawsuits and financial loss can increase as your business grows. 

If you have a substantial amount of personal assets (such as real estate, investments, and savings accounts), you might want to consider forming an LLC in the early stages of your business to ensure you are protected. 

To ensure the highest level of protection, you should make sure to keep your personal and business finances separate and keep accurate records of your LLC’s income and expenses. 

Hiring employees

When you start hiring employees, your liability can increase. Having an LLC can help protect your personal assets if you are faced with an employment-related lawsuit.

Signing contracts

When you sign a contract with another party, they can hold you legally responsible for holding up your end of the bargain. If something unexpected happens and the contract is breached, you want that liability to fall to your business, not you.

An LLC can provide liability protection if someone brings a lawsuit against your company or your LLC owes money to creditors. Keep in mind that if you have a sole proprietorship or partnership, as soon as your business starts making money—even if you only have one client—you can be held personally liable for your business’ obligations and debts. Creating an LLC can help protect your personal assets if your company is sued or creditors come after your business. 

Seeking investors

An LLC structure can attract potential investors or partners who are drawn to the legal protection and flexibility the entity offers. 

FAQs

Do I need an LLC to run a small business?

You don’t technically need an LLC to run a small business. However, an LLC can provide many benefits, including liability protection and tax advantages. 

Structuring your business as an LLC provides flexibility in tax classification. As long as you don’t elect to be taxed as a corporation, you can avoid double taxation, as the business’ profits and losses are passed through to the LLC member(s). Each member then reports the LLC’s income, deductions, gains, losses, and credits on their personal income tax return.

How do I start an LLC?

The steps to starting an LLC include choosing a name for your business, appointing a registered agent, deciding how your LLC will be managed, drafting an LLC operating agreement, and filing articles of organization. 

Can I convert my existing business into an LLC?

Yes, you can convert an existing business into an LLC. Converting a corporation to an LLC can provide tax advantages, flexible management, and profit-and-loss distribution options.

Can I form an LLC if I’m the only owner?

Yes, you can form an LLC if you're the only owner. A single-member LLC has only one owner, while a multiple-member LLC has two or more owners.

Jane Haskins, Esq., contributed to this article.