The world of personal finance is full three-letter acronyms: CPA, CFP, MBA, CFO, just to name a few. But there’s another set of three letters that’s been on my mind lately –
If you’ve spent any amount of time listening to the radio lately, you’ve probably heard the ads from sites like LegalZoom, offering to help you create an LLC for your business. But what exactly is an LLC, and just how can it help your business? As someone who is debating whether or not to form an LLC, I’ve done the research for you.
What Is an LLC?
LLC is short for limited liability company. That last word there – company – is really crucial. A lot of people erroneously think the “C” in LLC stands for corporation. It’s not, and in fact, that’s where many of the biggest benefits of forming an LLC stem from.
When you form an LLC, you are not incorporating. According to the Michigan-based Wipp Law Firm, an LLC is merely an unincorporated business association or partnership. Because an LLC isn’t a corporation, it gives you far more freedom, flexibility and protection than incorporated businesses.
LLC Advantage #1: Flexible Business Structure
When you form an LLC, you get to decide how to structure your business. LLCs are permitted by state statutes. The members of an LLC can include:
- Individuals (called single member LLCs)
- Other LLCs
- Foreign entities
According to the IRS, there are no limits on the number of members an LLC can have, meaning you could form an LLC with a hundred other people or groups or just one.
LLC Advantage #2: Tax Benefits
LLCs are not federal tax entities, which means you’ll have a lot of wiggle room when it comes to how you file your federal taxes. LLCs can opt to be taxed as partnerships, corporations, or as disregarded entities.
You can only opt to have your LLC labeled as a disregarded entity if you are its sole proprietor. By doing so, you are allowing the IRS to treat you and your LLC as one. You’ll have to fill out various 1040 schedules (Schedules C, E, and J, for example) to supplement your individual taxes, but you won’t have to file separate business and individual returns.
Multi-member LLCs that do not meet the criteria to be labeled a corporation for tax purposes are called partnerships. Similar to disregarded entities, the members of a partnership LLC file their own tax returns, paying self-employment instead of corporate tax. In this way, the company’s total profits are not taxed as a whole, but based on the percentage of earnings each member takes from the LLC.
State and federal guidelines may require an LLC to file as a corporation; however, even LLCs that are not required to be taxed as corporations may elect to do so by filling out IRS Form 8832. This is the most complicated way to tax an LLC, because it takes the self-employed nature out of filing returns. Instead of each individual reporting the income earned from the LLC in their filings, a corporate LLC eliminates self-employment tax; instead, it’s taxed as a corporation, at a corporate tax rate. This can have benefits, though, since incomes earned through the LLC via dividends are not subject to taxes under current IRS rules.
LLC Advantage #3: Personal Protection
For me, my main motivation behind forming an LLC – in my case, a single member LLC – would be for the personal protection it affords. An LLC does exact what its acronym stands for – it affords members limited liability. An entrepreneur whose business gets into debt – but doesn’t have an LLC – could lose his home or savings to creditors; likewise, a small business owner without an LLC who gets sued could be taken to the cleaners for everything they are worth, both as an individual and as a business owner.
An LLC literally puts up a wall between the individual and the company, protecting the individual’s assets (or, in the case of a multi-member LLC, the individuals’ assets) even if the business runs into financial or legal trouble. It makes the individual not liable for paying debts out of her personal funds should the business’s funds run dry. This is especially critical in multi-member businesses, where each shareholder is personally liable for 100 percent of the debts in the absence of an LLC.
Forming Your LLC
As I mentioned at the top, there are very cheap ways to form an LLC over the Internet. However, that takes a lot of the flexibility out of forming such a company, as these online sites tend to use a basic form that gives you far less wiggle room. Instead, visiting an attorney who specializes in business as well as consulting with a CPA can broaden the freedoms and protections of an LLC. One of my friend is such an attorney, and says he typically charges several hundred dollars an hour for this service. His advice? Start at a site like LegalZoom or Incorporate.com to get the basic paperwork done (LegalZoom’s base package, for example, costs less than $100), then bring in the information to an attorney, who can edit certain portions of it, reducing the hourly fees you’ll have to pay for their work.
Reader, do you have an LLC? Would you consider forming one for your business? Why or why not?