A. Limiting the Liability of its Members
There are many benefits to forming an LLC, which is why they have become the preferred business formation for small companies and start-ups. First and foremost is the protection it provides to its members’ assets which is also a characteristic that LLCs share with corporations, hence the term “limited liability.” Members will generally not be held personally liable for any debts incurred by the business. With a sole proprietorship or partnership, creditors can go after the business owners’ homes, bank accounts, and any other personal assets. Knowing that their personal property is protected from creditors by the LLC gives its members peace of mind and a level of comfort.
This isn’t to say that forming an LLC is a one way ticket to run up a boatload of debt and members not having to worry about having to pay it, avoiding any and all personal liability. There are certain business debts that creditors can pursue, such as business loans that are co-signed making both the individual members and the LLC equally responsible for repayment. Any obligation that is personally backed or guaranteed by a member can ultimately be pursued personally as well if the business cannot perform or defaults.
Another situation which can result in personal liability is if the LLC is not being used for a proper business purpose and instead, was created in an effort solely to provide protection. This is called “piercing the corporate veil” and while it is a somewhat complicated and difficult theory for creditors to prove, it is something that any business owner should be aware of if they are thinking of using the LLC form to do anything other than a legitimate business purpose. Be wary of mingling the funds of the LLC with personal funds and not being capitalized enough upon formation.
B. Taxation Benefits
The next big benefit that makes LLCs so attractive is the way in which they are taxed. The IRS does not have a specific tax code that applies to them. Strangely, in the IRS’s eyes, LLCs don’t even exist and are treated as a “disregarded entity.” In other words, federally, there is no differentiation between the LLC and its members and results in “pass through” taxation – the taxation passes through the LLC directly to its members. However, keep in mind that state tax laws could apply and cause LLCs to be taxed in other ways, so it is important to check your state laws and see what the possible tax implications are on the state level.
The reason this “pass through” tax treatment is a benefit over the corporate structure is that corporations are taxed separately, thus resulting in a kind of “double taxation” of any corporate income. With an LLC, the members report their profit and loss on their own individual tax return and there is no need to file a separate corporate tax return. And who doesn’t like being taxed less?
C. Less Burdensome and Less Hassle
As previously mentioned, LLCs do not have to adhere to the same requirements as other corporate formations. Corporate compliance can be overwhelming for small companies.. The paperwork required to form one is much less burdensome than that of incorporating your business. Again, there are variations from state to state that must be taken in to consideration but for the most part, it’s a two step process: 1. Filing the articles of organization (which usually includes a fee of $100, give or take) and 2. Creation of an Operating Agreement – this sets out the rules and regulations so to speak for the LLC. While some states may not require an operating agreement, it is highly recommended that one be drafted so that there are clear roles and responsibilities delineated for all its members. Once this is done (and all other licenses and permits have been obtained), the LLC is official and ready to do business. Also, check to make sure your state doesn’t require a further step of publishing a notice about the formation of your LLC.
Another requirement of corporations that LLCs don’t have to deal with is holding annual meetings and recording minutes of those meetings. Corporations must have an annual meeting with both its shareholders and directors. Corporations must also issue stock and appoint directors. Issuing stock in itself can be complicated and is governed by securities laws. With these additional requirements comes additional fees for legal and accounting expertise. LLCs don’t have to deal with those headaches and expenses.
D. Flexibility With Operations and Ownership
LLCs provide a lot of flexibility with how they can be managed. LLCs can choose to either by member managed or have separate managers. With member management, the members of the LLC all of the right to have a say in the day to day management of the business (such as entering into contracts) regardless of their percentage of ownership.
Separate managers can also be appointed, allowing people who have no membership interest to manage the day to day operations. Whichever way works for your LLC, the choice is up to you!