When embarking on a new business venture, you encounter numerous options. One path commonly followed by large, successful companies is to establish a corporation. However, you may have also heard that limited liability companies (LLCs) are advantageous for smaller businesses.
For aspiring LLC owners, here are six key benefits of choosing this business structure:
1. Limited Personal Liability:
If your business operates as a sole proprietorship or partnership, you and your business are legally considered the same entity. Consequently, your business debts are treated as personal debts. Additionally, if a business partner or employee faces negligence accusations, your personal assets could be at risk.
By forming an LLC, personal liability is limited since the LLC is recognized as a separate legal entity. The LLC is solely responsible for its debts and obligations. While your investment in the company may be at stake, personal assets such as your home and bank account are generally protected from being seized to settle business debts. Moreover, your personal assets typically remain safeguarded in the event of a lawsuit against an employee, business partner, or the business itself for negligence.
Related: LLC vs. sole proprietorship
2. Reduced Paperwork:
While corporations also offer limited liability, they must fulfill specific requirements that may not align well with small, informally run businesses. For instance, corporations typically have to conduct annual shareholder meetings, file annual reports, and pay annual fees to the state. Additionally, they are often burdened with extensive recordkeeping obligations.
On the other hand, LLCs are not obligated to hold annual meetings and usually have less stringent recordkeeping requirements. Many states don't require LLCs to file annual reports.
3. Tax Advantages of an LLC:
LLCs enjoy the benefits of various tax classifications. Although an LLC doesn't possess its own federal tax classification, it can adopt the tax status of sole proprietorships, partnerships, S corporations, or C corporations.
The Internal Revenue Service automatically classifies LLCs as partnerships or sole proprietorships, depending on whether there is a single owner or multiple owners. This enables LLCs to leverage "pass-through" taxation, where the LLC itself doesn't pay any LLC taxes or corporate taxes. Instead, the LLC's income and expenses flow through to the owners' personal tax returns, and they are subject to personal income tax on any profits.
In contrast, traditional C corporations face double taxation on shareholder distributions—once at the corporate level and again at the individual level. S corporations avoid double taxation and enjoy pass-through tax treatment, but not all corporations qualify.
4. Ownership Flexibility:
S corporations benefit from pass-through taxation, but they face several ownership restrictions. For instance, they are limited to a maximum of 100 shareholders, cannot include foreign shareholders, and are prohibited from having corporate shareholders. In contrast, LLCs can opt for pass-through taxation without any limitations on the number or type of owners they can have.
5. Management Flexibility:
Corporations adhere to a fixed management structure comprising a board of directors responsible for overseeing company policies and officers in charge of day-to-day business operations. Shareholders, or owners, must convene annually to elect directors and handle other company matters.
LLCs, however, are not bound to such formal structures. Owners of an LLC have more flexibility in running the business and making decisions, allowing for a customized approach.
6. Flexible Profit Distributions:
LLCs possess the flexibility to distribute profits among owners according to their preferences, without the requirement for equal or proportionate distribution based on ownership percentages. For example, two individuals with equal ownership interests in an LLC might agree that one of them will receive a larger share of profits due to contributing more capital or labor during the business's startup phase.
In contrast, corporations must distribute profits to shareholders based on the number and types of shares they hold.
The simple and adaptable structure of an LLC makes it an ideal choice for many small businesses. While both corporations and LLCs offer limited personal liability to owners, LLC owners can also benefit from tax advantages, management flexibility, and reduced recordkeeping and reporting obligations.