Updated: Mar 20, 2020
Entrepreneurship comes with a lot of decision-making. One of the most important decisions is choosing a legal structure for your business. A common choice for many entrepreneurs is a LLC, but why? LLCs are a “hybrid” business entity that combines the limited liability protection of a corporation, the pass-through taxation scheme of a partnership, with the added perk of management flexibility that neither a corporation or partnership can offer.
Wondering if a LLC may be right for you? Read more to find out!
1. Management Flexibility!
The owners of a LLC are referred to as “members.” A LLC can be owned by a single member or multiple members. When it comes to determining a management scheme, the owners of a LLC can choose to manage their LLC themselves (e.g. “member-managed.”) Alternatively, the owners can opt to bring in outside managers to run the LLC (e.g. “manager-managed”). The key to the management flexibility offered by a LLC lies within the operating agreement. An operating agreement is a legally enforceable contract that governs the internal operations of a LLC. Generally, an operating agreement fleshes out the relationship between the members, the process for adding new members, allocation of profits, capital structures, dissolution, voting rules, transfers of ownership etc. The appeal of forming a LLC is that this operating agreement can be drafted according to the members' desires! This differs from corporations which are subject to many in-depth statutory requirements regarding management and the power-dynamic between directors, officers, and shareholders. Beyond this, an operating agreement can be easily modified or amended in the future. It is important to note that if there is no operating agreement in place for your LLC then state law will apply. Because of this, we recommend implementing an operating agreement to govern your LLC that incorporates your wants and needs. For assistance with drafting an operating agreement please contact our office at firstname.lastname@example.org.
2. Limited Liability!
A LLC is its own legal entity, separate and apart from its members. Practically speaking, this means that a LLC can conduct business in its own name, own property in its own name, enter into a contractual agreement in its own name, file lawsuits in its own name, etc. Because a LLC is a separate legal entity, the members are not personally liable for the debts and obligations of the LLC! This is one of the most important advantages of operating as a LLC. However, it is also important to note that this limited liability is not absolute. Under certain circumstances, a court could decide to “pierce the corporate veil” and hold members personally liable for the debts and obligations of their LLC. The most common instances of “piercing the corporate veil” occur when the members fail to maintain the legal separation between their business and personal finances (e.g. commingling funds) or where the LLC is used to perpetuate a fraud or injustice. Remember, the limited liability afforded by a LLC is a gift, so don’t jeopardize it!
3. Pass-Through Taxation & Tax Flexibility!
By default, the IRS treats single-member LLCs as disregarded-entities and multiple-member LLCs as general partnerships. Under both default tax structures, a LLC is still deemed a pass-through entity. This means that the profits and losses of a LLC pass-through to its members and are reported on their personal tax returns and the entity itself is not taxed. This differs from C-corporations which are subject to double taxation meaning that the corporation is taxed as separate entity and shareholders are also taxed at the personal level for distributions received from the corporation. Under the IRS default rules, all of the profits of a LLC are only taxed once which is another advantage of operating as a LLC! However, it is important to note that the IRS default rules aren’t the only tax structures available to LLCs. Members can choose to be taxed as a S-corporation, C-corporation, or even as a sole proprietorship. We recommend consulting with an accountant to determine which tax structure works best for your business.
Overall, operating as a LLC provides entrepreneurs with a lot of flexibility and benefits making it an attractive option. For more information on LLCs or for assistance with forming your LLC, please contact our office at email@example.com.
Already formed your business? Now it’s time to protect it, check out our
Shade, Joseph. Business Associations In A Nutshell . 3rd ed., Thomson Reuters, 2006.