Advantages and Disadvantages of a Limited Liability Company

What entity structure do you choose? A lot of the time a Limited Liability Company is a good fit, but make sure you know and trust your partners. Below are some advantages and disadvantages.

Advantages and Disadvantages 

Advantages

  • A limited liability company can have more than one member (owner.)
  • Members do not have to contribute money, they can contribute any tangible or intangible property in exchange for a membership interest.
  • Member interest is transferable.
  • All of the members have the benefit of limited liability from the obligations and liabilities of the entity, including if they participate in the management of.
  • Can be taxed as a partnership, on a Schedule C if a single-member LLC or husband-wife LLC, or elect to be taxed as a corporation.
  • If taxed as a partnership or on your personal return, the income of the business is only taxed once and losses can be used to offset other income.
  • A limited liability company taxed as a partnership can divide the gains and losses between the members for tax reporting without regard to how much capital they contributed.
  • A LLC taxed as a partnership can be converted to another business structure in a tax-free transaction.
  • A LLC can be managed by either its members or by a manager. This allows the LLC to choose the best structure for decision-making purposes.
  • If a manager-managed LLC, those that do not participate in the management do not have to pay self-employment taxes on their share of income.
  • If a manager-managed LLC, the business survives death or incompetence of a manager that is not a member.
  • No requirement to have formal meetings.
  • Depending on the State organized in, you may be able to withdraw and receive fair value of your interests from the limited liability company.

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Disadvantages

  • Unless a manager-managed LLC, members will have to pay self-employment taxes.
  • Since all members and managers have the right to participate in management, disagreements between members can occur.
  • Other members or managers have the authority to bind the entity in the ordinary course of business.
  • All members must provide consent if transferring your interest to another party.
  • A limited liability company could be dissolved if a member withdrawals, dies, goes bankrupt or is otherwise incapacitated, unless there is an operating agreement in place that provides instructions as to what happens in the event of that happening to a member.
  • Requires a State filing in the State of organization and the States doing business in.


What is a Limited Liability Company (LLC)

A limited liability company (LLC) is a business structure that gives the members (owners) liability protection and the ability to pass profit and losses to their personal tax returns.

This basically blends a corporation and a partnership. Instead of the owners being responsible for the liabilities of the business, creditors would need to go after the business’s assets. This is different from a partnership or sole proprietorship, where creditors can go directly after the personal assets of the owners and partners.

But like sole proprietors and partnerships, the income and losses can flow to the member’s personal tax return. LLCs have many different options in filing taxes:

  • Single-member LLCs can file on a Schedule C of the member’s personal 1040
  • Husband and Wife LLCs can do the same as a single-member LLC
  • LLCs with two or more partners usually file Form 1065, the partnership tax return. The members will receive K-1s they will report on Schedule E of their personal tax return
  • A LLC can file Form 8832 and elect to be taxed as a C corporation
  • A LLC can elect to be taxed as a S corporation by filing Form 8832 and subsequently file Form 2553.

Who Should Consider Starting a LLC

I recommend using a LLC structure for most businesses that may face creditor claims or potential lawsuits.

You do not want to work for years building your business and saving money annually, only to lose everything due to legal fees or a judgment

Note that even though the LLC offers liability protection, the members can still be liable in certain situations. Some of the ways the corporate veil can be pierced:

  • Members not separating assets (i.e. not having a separate bank account for the business)
  • Illegal activities within the business
  • Knowingly not correcting an unsafe situation on the premises

To be safe, I would create an LLC or S or C-Corporation for many businesses that has property, uses labor (in-house, contract or temporary), and many that provide a product or service.

If you do all of the labor in a small service or provide a commodity product that doesn’t have liability, you may be ok to use a sole proprietorship or partnership. Otherwise, in most States, it only costs $100-200 more per year to maintain a LLC. It’s considerable higher in some States like California, which charge a franchise tax.

There are some businesses that are prohibited from creating LLCs: banking and insurance. Some States (like California) do not allow licensed professionals to start LLCs: law practices, CPA firms, doctor offices, etc.

My CPA firm is organized as a Professional Corporation (PC.) I see a lot of law offices organize as Limited Partnerships or Limited Liability Partnerships.

How Do You Form a LLC

Most States just require you to submit an Articles of Organization and pay the filing fee. Many States, including my home State, Georgia, allow you to file the Articles of Organization online with the Secretary of State.

In Georgia, it only takes about 20 minutes to go through the entire process. Right before or immediately after, you must submit your Intent to Form a LLC with your local newspaper. The rate will vary by publication.

I hope this helps you in your decision as to whether to form a LLC.

If you have a LLC and need help preparing your taxes, reach out to me at ValdostaCPA at Yahoo.com. I have clients in most States and many countries. If you have a Smartphone, Scanner or feel like mailing me your forms, I can prepare your taxes.

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