School’s back in session and a new season of learning has begun. But for entrepreneurs, the learning never ends. And it starts from the very beginning when you’re faced with choosing the legal structure for your business.
Selecting the right legal structure—sole proprietor, LLC (Limited Liability Company), S-Corporation, or C-Corporation—affects multiple aspects of your business. From liability protection to taxes to ongoing compliance requirements, you need to study up on the options so you’ll know enough to make the right choice.
For many small businesses, the LLC structure offers a lot of advantages. So I’m going to give you a head start on your homework and share more about it here.
What to Love About the LLC Structure
Protection of personal assets – Because the LLC is a legitimate corporate entity, it provides a degree of separation between your personal assets and those of your business. In the event of legal action against your company, your home, family car, your kids’ college funds, and other personal property will be protected. This is a big advantage over running your business as a sole proprietorship.
Easy breezy – With an LLC, you’ll have less formation paperwork and ongoing compliance requirements to haggle with than you would with an S-Corporation or C-Corporation. You don’t have to create a board of directors, create annual reports, hold annual shareholders meetings, or deal with the other formalities that come with incorporating your business. Got an aversion to complexity? Then the LLC may be the right choice for you.
Taxation flexibility – As an LLC, you may opt to have your taxes treated as though you’re an S-Corporation or have your business profits pass through to your personal federal income tax return.
With S-Corporation tax treatment, self-employment taxes (FICA and Medicare) are only applied to salaries and wages, not distributions paid to you or other LLC members. If you choose pass-through tax treatment, your business’s profits and losses get passed to your members’ personal tax returns. So if your business isn’t profitable, you’ll lower your personal income tax obligation.
Professional Cred – With “LLC” following your company name, you have some added credibility in the eyes of customers, prospects, vendors, and the business community. Not that you wouldn’t be taken seriously as a sole proprietor, but forming an LLC can help instill confidence and trust.
Potential Disadvantages of the LLC
While there aren’t many downsides to operating as an LLC, the structure isn’t right for everyone.
Possible confusion over roles and responsibilities – If your LLC has multiple members, you may clash over who should be doing what and who is authorized to make certain decisions. Unlike the S-Corporation and C-Corporation, roles aren’t specifically defined. With an Operating Agreement, however, you can avoid the shades of gray and clearly define roles and responsibilities.
Sting of self-employment tax – While pass-through tax treatment may benefit you, it could instead work against you. If you don’t select S-Corporation tax treatment, all profits will flow to your personal income tax return and get hit with the social security and Medicare taxes. Depending on your situation, that could result in more tax than if you’d be taxed as a corporation.
Challenge to grow – Unlike with S-Corporations and C-Corporations, LLCs don’t sell stock. With no shareholders as a source for generating funds, you may find it challenging to grow your business as quickly or to the degree you’d like.
As you can see, forming an LLC offers a number of upsides, but don’t ignore the downsides. Choosing the legal structure for your company will be one of the key decisions you’ll make when starting a business. I recommend learning all you can about the options before you select which one is right for you. So study up! And ask both legal and accounting professionals for guidance in the process to ensure you’ve done all the homework necessary to decide what’s best for your business.