Is an LLC the Right Kind of Company for Me?
The entity you use for your business should be chosen thoughtfully. Each entity type has its own positives and downsides, and nothing is a perfect fit for all goals. In this post we’ll focus on limited liability companies (aka “LLCs”).
What is a Limited Liability Company?
An LLC is a pretty new type of business entity that is kind of like a middle ground between corporations and partnerships. How new are they? The first LLC was formed in Wyoming in 1977, and the IRS didn’t decide how they would be taxed until 1998—in fact, while LLCs abound in New York, the state didn’t recognize LLCs until 1994.
LLCs are so new that the federal government does not recognize them. Instead, companies formed as limited liability companies are faced with a default tax classification: “disregarded” for single owner LLCs, and partnerships for multi-owner LLCs; in either case, profits and losses of the business go directly onto each owner’s tax returns. Depending on state law an LLC may be able to elect S-Corp status.
LLCs are flexible and agile entities. Owners are referred to as “members” having “membership interests.” These membership interests can be broken into classes having different rights to profits and management. While membership interests are often expressed as percentages, they can be broken into “Membership Units” like shares in a corporation.
Benefits of Using an LLC:
Limited Liability: Just like in a corporation, LLC members are not personally liable for the company's debts and liabilities. This means your personal assets (like your home or car) are typically protected if your business runs into financial trouble.
Flexible Taxation: An LLC can choose how it wants to be taxed. By default, it's treated like a sole proprietorship or partnership (depending on the number of owners), with profits and losses passing through to the members' personal tax returns. However, an LLC can also elect to be taxed like a corporation or an S-Corp if that is more beneficial.
Management Flexibility: LLCs have flexible management options, they can be member-managed (run by the members themselves) or manager-managed (run by appointed managers, who can be members or outsiders); management rights can divided by class, or even by topic. LLCs can be managed informally by a sole member, or they can have a Board of Managers like Directors in a corporation.
Downsides:
“Self-Employment” Taxes: Because of the pass-through nature of LLC taxation, owners may need to pay both sides of FICA taxes on their shares of the business’ profits, which can be higher than with other tax bases.
Investor Limitations: Because of the pass-through nature and because LLCs are so new, frequent investors (like venture capital) may require you operate as a corporation before investing money. Additionally, if you plan on scaling very large, you won’t be able to go public with an LLC.
Limited Life: In some states, the LLC might automatically dissolve when a member leaves or passes away, although this can often by changed by agreement.
TL;DR
LLCs are fairly new and extremely flexible entities, but your specific circumstances will determine whether it’s the optimal business form. Before getting too deep, it’s wise to consult with an experienced business attorney who can help guide you through the process. If only you knew where to find one…