The Limited Liability Company (LLC) business structure is a popular choice for entrepreneurs who want to protect their personal assets, enjoy tax and management flexibility, and keep corporate formalities to a minimum. In this article, I’ll discuss the main benefits of creating an LLC to help you understand why so many business owners choose this entity type for their companies.
7 Top Advantages of Registering an LLC
1. Simplicity
The business registration paperwork to form an LLC is minimal, as are the ongoing filing requirements.
It’s second only to the Sole Proprietorship and General Partnership in terms of simplicity when it comes to annual compliance responsibilities. In a way, it’s a sort of hybrid, providing the simplicity of a Sole Proprietorship or Partnership and the personal liability protection of a Corporation. For instance, an LLC does not have to maintain annual meeting minutes like Corporations do. They can if they want, but they don’t have to because it’s not a state requirement. Also, while many states require Corporations to file an Annual Report every year, some states only require LLCs to file a Biennial Report (every two years).
2. Personal Protection
The main benefit of the LLC structure, as its name suggests, is that it limits the liability of the business owners. Because an LLC is considered a separate legal entity from its members, its financial and legal responsibilities are also its own. Therefore, an LLC gives business owners peace of mind that their personal assets are protected. This is an advantage over the Sole Proprietorship and General Partnership because in those structures the business owner and the business are considered the same tax-paying and legal entity, making the business owners personally liable for all financial debts and legal problems associated with the business.
An LLC’s creditors can go after the business bank accounts and other property, but typically, they may not touch the members’ personal property, such as personal bank accounts, home, or car. Each member’s liability is limited to their capital contribution to the LLC. It’s important to realize, however, that if an LLC member or an employee commits wrongdoing, malpractice, or negligence during the course of doing business, that individual could be held liable for their own actions, putting their personal assets at risk. Co-owners of the LLC who are not involved in the wrongdoing or negligence would remain protected from liability.
Also, if an LLC member has personal debt or legal issues, the LLC’s money or property cannot be taken by creditors or plaintiffs to satisfy personal debts or claims against the owner.
3. Pass-Through Tax Treatment
By default, an LLC is not considered a tax-paying entity. Instead, income tax is applied similarly to Sole Proprietorships and Partnerships. Income and expenses pass through to business owners’ personal tax returns.
A Single-member LLC is considered a “disregarded entity” for tax purposes and is taxed as a Sole Proprietorship. A Multi-member LLC is regarded as a Partnership for tax purposes and taxed as such. In both scenarios, all profits, losses, and tax responsibilities pass through to the LLC members’ personal tax returns. LLC members report their LLC’s income and expenses on Schedule C, E, or F, depending on their business activities.
Alternatively, LLC members may elect to have their company taxed as an S Corporation if the entity meets the IRS’s eligibility requirements. Being taxed as an S Corporation means that members will only pay self-employment (Social Security and Medicare) taxes on their wages and salaries, not on any distributions they receive, lessening their personal tax obligations.
Another option is to be taxed as a C Corporation, which isn’t quite as popular among small businesses operating as LLCs. This is mainly because certain profits are double taxed when distributed to shareholders as dividends.
4. Flexible Allocation of Profit and Loss
In an LLC with multiple members (Multi-Member LLC), the LLC members may allocate profits and losses amongst themselves however they want. They are not restricted to allocating profits and losses according to each LLC member’s ownership percentage, as is the case with a Corporation. That flexibility can help ensure fair compensation for business owners who are doing most of the day-to-day work in the business but may have invested less money in it. The company’s LLC operating agreement should define how profits and losses are distributed to LLC members. If there is no LLC operating agreement or the agreement does not have language describing the distribution methodology, the default rules of the state where the LLC is registered apply. In many states, the default rules stipulate that members must share income distributions equally, regardless of their individual capital investment in the entity.
5. Financing and Credit
Financing and credit can be easier to obtain as an LLC because the company is a formal legal entity. Sole Proprietors and Partnerships sometimes have difficulty getting business financing because the business owner must personally guarantee the loan or funding. Banks, other lending institutions, and investors may consider that risky. Forming an LLC can demonstrate legitimacy and make banks and other lenders feel more confident about offering financing.
6. Management Flexibility
An LLC may be either member-managed or manager-managed. A Member-managed LLC means the LLC members oversee the day-to-day business activities as well as handle ownership responsibilities. A Manager-managed LLC means the members have appointed someone else (although it could be one of the members) to manage the daily operations.
7. Unrestricted Ownership
Most states do not place restrictions on who may own an LLC. Generally, an LLC may be owned by individuals (even non-resident aliens), Corporations (with the exception of certain types of businesses, like banks and insurance companies), other LLCs, foreign entities, trusts, and Partnerships.
Also, an LLC may have an unlimited number of members. (One caveat to consider: if an LLC’s members decide they want to seek S Corporation election, they may not do so if the LLC has more than 100 members or if any of the LLC’s members are Partnerships, Corporations, or non-resident aliens.)
Types of LLCs
Different variations of LLCs exist. Several refer to the number of members an LLC has, how it’s managed, and where it conducts business:
- Single-Member LLC – If the LLC has just one owner, it’s considered a Single-member LLC. By default, the IRS treats this LLC as a Sole Proprietorship for income tax purposes.
- Multiple-Member LLC – This LLC has more than one member. The IRS treats it as a Partnership for income tax purposes.
- Member-Managed LLC – In this LLC, the business owners run the company’s day-to-day operations.
- Manager-Managed LLC – This LLC appoints a manager (or multiple managers) to run the company’s daily operations. A manager can be someone on the outside who the members hire, or an LLC member may take on the role of manager.
- Domestic LLC – An LLC is considered a Domestic LLC in the state where it submits its formation forms to register as an LLC.
- Foreign LLC – An LLC registered as a Domestic LLC in one state is considered a Foreign LLC in any other states where it files to conduct business. Filing and LLC to operate as a foreign entity in other states is called Foreign Qualification.
Other versions of the LLC structure are relative to certain types of businesses:
- PLLC – A Professional Limited Liability Company is used for business owners licensed in a particular profession (such as doctors, lawyers, accountants, engineers, architects, etc.).
- Series LLC – A Series LLC consists of an umbrella LLC (a.k.a. a parent LLC) and one or more sub-LLCs (or child series). Each sub-LLC operates as a separate business while being maintained by the primary entity. This LLC variation is popular with real estate investors and other companies with multiple locations or business lines.
- Low-Profit LLC – Also known as an L3C, a Low-Profit LLC is a relatively new LLC variation and is available in only certain states. This LLC option is available to for-profit businesses that put making a profit secondary to its objective of providing a service to the public.
Keep Learning About LLCs
You have many details to consider when selecting a business entity type for your company. It’s advisable to talk with an attorney, accountant, and tax advisor for guidance before making a decision.
As you prepare for those conversations, we have many other articles to help you understand the Limited Liability Company structure and get a sense if it’s an option worth exploring for your business.
- Understanding the Various Types of LLCs
- Professional Corporation vs. Professional LLC
- Single Member vs. Multiple Member LLC
- Member vs. Manager-Managed LLC
- Domestic LLC vs. Foreign LLC
- Sole Proprietorship vs. LLC
- LLC vs. Partnership
- LLC vs. C Corporation
- S Corporation vs. LLC
- DBA vs. LLC
- LLP vs. LLC
- LLC vs. PLLC
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