LLC: Pros and Cons
The state of Wyoming enacted the first Limited Liability Corporation in 1977, but, due to uncertainty of treatment from the IRS, it wasn’t until the late 1980’s that this entity type really gained widespread acceptance. But what is an LLC?
An LLC (Limited Liability Company) is something of a hybrid, combining features of a corporation with features of the simpler business entity types. While the LLC is a very new form of business, it is increasingly popular, and is an option for both single- and multi-owner businesses. As a formal business structure, an LLC requires registration with the state in exchange for the various protections and flexibilities not offered to the simple structures. A feature of the LLC is that its owner(s) elect whether to be treated like a sole proprietorship, partnership, or corporation for tax purposes while still receiving LLC protection.
- Flexible ownership. While a sole proprietorship can only be owned by its founder, and a general partnership by default is limited to its founding partners, an LLC provides more flexibility for owners. You can just as easily form a single-member LLC as a multi-owner LLC, and ownership can be transferred from one person to another (although not as easily as with a corporation) with the approval of other members. The business has a life of its own, and is separate from the lifespan and/or involvement of its founder(s).
- Flexible tax preparation. LLCs elect their tax status: whether they will be taxed like corporations, or as a pass-through entity like the sole proprietorship or general partnership. If the LLC elects the pass-through option, then all profits are taxed on the individual LLC member returns, not at the company level. Note that multi-owner LLCs must still file for an informational tax return, even though the profits are not taxed at that level.
- Limited liability. As the name suggests, LLCs offer limited liability to their members. As long as the LLC’s members follow procedures to keep their business and personal finances separate, members’ personal assets are protected from creditors and lawyers. Only the business’s assets are at risk.
- Formation and maintenance requirements. While the simpler entities are formed automatically, an LLC requires the business owner(s) to file documents with the state (usually called either a Certificate of Organization or the Articles of Organization) and pay a filing fee. Each year, the LLC will also have to pay a fee or tax (depending on the state and details of the business) to maintain the entity.
- Compliance procedures. In order to receive the limited liability protection, members must be careful to keep their personal assets separate from the company assets. If the business’s assets are under attack and investigation reveals that there has not been a strict wall of separation, then the corporate veil can be pierced, and liability protection lost.
- No stock. Unlike a corporation, an LLC cannot issue stock to raise capital by attracting investors.
Do you have questions about entity types? Download our free incorporation guide.