Starting an LLC: Do the benefits outweigh the costs?
A limited liability company is a business structure with various advantages and disadvantages for the business owner. It is a hybrid business structure that exploits the tax advantages and flexibility afforded to a partnership while providing the liability protection you get to benefit from if you have a corporation.
Before we go any further, you first have to understand what a limited liability company is.
What is an LLC?
An LLC can have one for several members officially termed as the owners. Members can either be businesses or individuals, and there is no limit on how many an LLC can have. With a limited liability company structure, the personal assets of every member are protected from any business creditors.
The number of LLCs continues to increase drastically worldwide, and this is easy to explain given the various advantages they offer. You can consult a business formation service to gain more insight into the process of starting an LLC. In this article, we look at the advantages and disadvantages that come with a limited liability company structure to help you decide whether it is the ideal structure for your business.
Benefits of an LLC
Working with a limited liability company structure for your business comes with various advantages, as seen below.
With an LLC structure, members of the company do not have any personal liability for the actions of the company. As a result, the personal assets of every member have protection from any business creditors that may want to collect from the business. You get to enjoy this level of protection as long as you keep your business operations on the up-and-up and separate personal and business finances.
Pass-through federal taxation on profits
Unless it decides otherwise, an LLC functions as a pass-through entity, this simply means that all the profits go directly to the members without any taxation by the Federal government at the company level. Instead, they get taxed on the members’ federal income tax returns. Because of this, limited liability companies have an easier time filing taxes.
When operating an LLC, you can choose to have the members manage the business. This way, every member gets to take part in the decision-making process. Alternatively, members of an LLC can choose to hire managers from outside, which can be quite beneficial if they have no experience in operating a business. In most areas, LLCs are managed by the members by default.
Before you choose to register your business as an LLC, make sure you consider these potential disadvantages.
Limited liability can be compromised
In a court proceeding, a judge can determine that the limited liability company structure does not protect the members’ assets. It mostly happens in action called “piercing the corporate veil,” which you can be at risk for if you do not separate your personal transactions from the business transaction. It can also happen if you fraudulently operate the business, resulting in losses for other parties.
The IRS views limited liability companies as partnerships for tax purposes atlas members accept to be taxed as a corporation. If an LLC gets taxed as a partnership, the members are considered to be self-employed. This means that they are personally responsible for making Medicare and Social security taxes, referred to as self-employment tax. They can vary depending on the net earnings of the business.
If your limited liability company opts to get taxed as an s corporation, the members pay social security and Medicare taxes based on actual compensation and not the total pre-tax profits made by the company.
The consequence of member turnover
In most areas, you will have to dissolve the company if one member of the LLC goes bankrupt, dies, or leaves the company. The remaining members of the LLC take responsibility for all the remaining financial and legal obligations that go into the process of terminating the business. Although the members can still conduct business, they will have to go through the process of starting an entirely new limited liability company from scratch. It can be a costly and time-consuming process, especially for a growing business.
Limited liability company structure offers various advantages and disadvantages. On the upside, the members get to benefit from limited liability and management flexibility. Pass-through federal taxation on profits is also another benefit associated with LLCs. Some of the biggest disadvantages of LLC company structures include self-employment tax and the consequence of member turnover. The fact that limited liability can be limited also presents another disadvantage.