Choosing a business structure: Is an LLC the best choice?
Are you ready to incorporate your new business? If so, you’re in the right place. Choosing the proper structure for your business is one of the most important decisions you’ll make early on. You probably have a lot of questions, and we’re sure you’d be the first to admit that there’s a lot that you don’t know. Don’t let your lack of knowledge and confusion rush you to choose an LLC just because you don’t know any better.
By the end of this article, you may choose to incorporate it as an LLC. Regardless, you will know all the facts and make an informed decision. Continue reading to discover if an LLC is the proper structure for your new business.
What is an LLC?
An LLC (or limited liability company) is a popular business structure designating a business as a formal legal entity. Establishing an LLC can help an entrepreneur establish credibility for their businesses. LLCs are also the most common ways for business owners to protect their personal assets. LLCs are registered with the state. They can be used to run a business or hold assets like real estate, aircraft, or vehicles.
The owners of an LLC are called members. One person owns a single-member LLC. An LLC owned by multiple people is called a multi-member LLC. To create an LLC, you must pay your state a filing fee and file LLC formation documents.
Benefits of an LLC
So, why would you file as an LLC? Let’s get into the main benefits.
Forming an LLC creates a protective wall between your business and your personal assets. Personal assets include everything you own, from your property, vehicles, bank account, valuable assets, and more. If your LLC is sued, creditors can only legally go after the LLC’s bank accounts and other assets. Your personal assets are safe and not considered a part of the business.
Easy to start and maintain
Compared to a corporation, LLCs are easy to create and maintain. This business structure faces fewer state-imposed compliance requirements. This is compared to corporations, general partnerships, and, believe it or not, sole proprietorships. Most states only require you to file the Articles of Organization.
LLCs allow for pass-through taxation because their income isn’t taxed at the entity level. Pass-through taxation means the company’s profits and losses aren’t taxed on a corporate level. Instead, the tax liability is passed on to the LLC members to claim on their personal tax returns. This allows LLC members to avoid double taxation, which many corporations fail to avoid.
Note: You still must complete a tax return for the LLC if it has more than one member. Any income or loss is passed through to the owners, a.k.a members.
There’s a reason why LLCs are considered the most flexible business structure. Until 1977, when the first LLC statute was enacted, if you wanted to protect your personal assets, your only option was an S corporation. As you'll soon learn, a corporation is a corporation that elects to pass corporate income, losses, deductions, and credits through to its shareholders for federal tax purposes. Unfortunately, they are inflexible in many ways.
The downsides of an LLC
LLCs have many advantages, but there are a few reasons you would choose another business structure.
- Startup Costs: Compared to a sole proprietorship or general partnership, LLCs are more expensive to operate.
- Ownership Transfers: It’s often harder to transfer ownership of an LLC compared to a corporation. With corporations, shares of stock can be sold to increase or decrease ownership.
- Investment: LLCs are not great options for investment. This is why most investors are not willing to invest in LLCs. They don’t have the specific tax advantages and ease of share transferability provided by corporations.
What are my other options?
If you’re the only owner in your business and haven’t formed a business entity, then you are a sole proprietor. This means there’s no legal distinction between you and your business, essentially making you your own boss. The only thing you’ll need for a sole proprietorship is a DBA (doing business as) if you want to secure a trade name.
If you’re wondering if you need to turn your side hustle into an LLC, then no, you don’t need an LLC for your side hustle.
Sole proprietorships don’t have any ongoing maintenance responsibilities. There is one BIG drawback of staying a sole proprietor - you don’t have any protection. This means you are personally liable for any debts and obligations your business incurs. As we’ve discussed, this means creditors can go after your personal assets. Most notably, your personal bank account and home can be used to satisfy creditors.
Sole proprietorships are best suited for business owners with minimal to zero liability. They're also good options if you don't have employees or significant contracts with landlords, suppliers, subcontractors, etc.
Partnerships (LPs or LLPs)
A partnership is a type of business where 2-20 people join hands to run a business for profit. Partners share money, resources, and skills to help the business grow. They also share the profits and losses in a business.
Advantages Of A Partnership
The main advantage of a partnership is that with more owners, more people are thinking on behalf of the business. Sometimes, running a business on your own can slow you down when you encounter problems requiring outside knowledge. In addition to shared knowledge, you also have more capital available working with a partner.
Disadvantages Of A Partnership
The main disadvantage of partnerships is unlimited liability. If your business defaults on a bank loan, the bank has the right to take personal assets from the owners to recover their loss. Tax responsibility works the same way, meaning tax liability remains with the partners, so the IRS can come for personal assets if your business is not compliant.
Corporation (C-Corp or S-Corp)
A corporation is a more complex business entity compared to sole props., LLCs or partnerships. This business entity is more formal, less flexible, and requires more operating procedures. Corporations pay income tax on their profits. Double taxation may occur when a corporation earns a profit in the form of dividends. In this case, the corporation will first pay taxes on its annual profits. Then, after the corporation pays its dividends to shareholders, shareholders will pay a second tax on their personal tax returns.
Advantages of corporations
Although corporations are more difficult to form and maintain, they are much more investor-friendly. Investors exceedingly prefer corporations (c-corps, to be specific) over LLCs. Corporations, by design, have freely transferable shares. This makes corporations popular choices among startups with big growth aspirations and plans to take on investments.
What’s the difference between a C-Corp and an S-Corp?
Well, one main difference is how the law allows the transfer of shares. While S-Corps are also designated to issue shares, there are several restrictions on who and how many people shares can be distributed to. S-corps are limited to 100 shareholders, who all must be United States citizens or residents.
Disadvantages of corporations
LLCs are only required to file Articles of Incorporation, while Partnerships and Sole Proprietorships only need DBAs. Corporations, on the other hand, require a few more legal documents, including:
- Articles Of Incorporation
- Action of Incorporator
- Shareholder agreements
- Founder stock purchase agreements
The setup for a corporation is expensive and may require outside assistance. Once you file all of the necessary documents, the wait time could be weeks or months, depending on your state.
Corporations also have stricter maintenance calendars. They’re required to hold periodic board meetings, keep minutes of all meetings, pay annual filing fees, and file annual reports and statements.
LLC or not, ComplYant can help
There are a lot of factors to consider when deciding on a business structure. From this article, you’ve learned that staying as a sole proprietor is perfectly acceptable, but you’re assuming more risk as your business grows. You also know the advantages and disadvantages of an LLC. While there are few concrete disadvantages to forming an LLC, there are advantages to structures like corporations that you cannot benefit from with an LLC.
Whether you form an LLC, stay a sole proprietor, or jump to forming a corporation, ComplYant can help you. We have the tools to help any business stress less about business tax. Sign up for a free ComplYant account to save time and reduce financial barriers to creating a business.