To LLC Or Not To LLC? If this is the question you're trying to answer, our Legal Expert can help you decide if this business form is right for you.
Opinions expressed by Entrepreneur contributors are their own.
Deciding whether to scramble aboard the LLC bandwagon is one ofthe most important decisions you'll make in forming yourstart-up, so it shouldn't be taken lightly-no matter whatthe headlines say. An LLC structure gives you the flexibility andtax benefits of a partnership plus the personal liabilityprotection of a corporation. In 1977, Wyoming became the firststate to adopt the LLC format, rooted in European and LatinAmericans laws, and the 49 other states have since signed on. Butshould you?
Not without thinking about what your personal and business needsare. As Marc-DavidSeidel, assistant professor of management at the McCombs Schoolof Business at the University of Texas, Austin, puts it: "Askyourself if you really need the additional liability protectionoffered by the LLC structure. If not, it's less expensive andmuch easier on the paperwork to simply operate as a soleproprietorship."
And Seidel isn't lecturing from an ivory tower, either. Hestarted two LLCs, both operating through a system of contracts withthird-party providers. Let's look at the advantages an LLCoffers.
Why LLC?
Limitedliability. Your only risk is capital paid into thebusiness. Business debts and other liabilities can't besqueezed out of your personal assets. Caution: If you personallyguarantee a debt, you've forfeited your "limitedliability."
Tax simplicity.Profits and losses are reported and taxed on owners' individualreturns. There's no separate business tax return, unless youhave more than one member and choose to be taxed as a partnership(Form 1065). And there's no corporate "doubletaxation," in which both the business and the shareholders aretaxed.
Flexiblemanagement. A "member" (shareholderequivalent) can be a person, partnership or corporation. Membersget a percentage of ownership. If your idea people can't managetheir way out of a paper bag, you can hire management help. SmallerLLCs are usually member-managed, but not always.
Flexibledistribution. Profits and losses don't have to bedistributed in proportion to the money each person puts in. Aregular C corporation can't allocate profits and losses. And ina subchapter S corporation (taxed as a partnership), profits andlosses are in proportion to shares held.
Why Not?
And now for the downsides:
No stock. LLCsare tough if you have several investors or raise public money,since you don't have shares or stock certificates to offer. Ifyou give a percentage of ownership to outside investors, you mustdecide whether they're managing members. Seidel cautionsentrepreneurs: "Ask yourself if you need more flexibility interms of corporate stock ownership, financing options, etc. If so,the LLC is probably not a good idea--try a C corporation."
Two's acrowd. LLCs in most states require only one member: you.But if you live in Massachusetts or the District of Columbia, youmust have two members, and that could be a deal-buster.
Fewer incentives.LLCs aren't ideal if you want to give fringe benefits toyourself or employees. Unlike with a C corporation, you can'tdeduct the cost of benefits with an LLC. And since there's nostock, you can't use stock options as incentives for youremployees.
Paperwork. LLCsfile articles of organization with the State Corporation Commissionor Secretary of State and draft an operating agreement listingmembers' rights and responsibilities. Some, like an applicationfor employer ID number (IRS Form SS-4) and choice of tax status(IRS Form 8832), are one-shot; others (annual report, quarterlywithholding and tax deposit coupons, and business bank account) areongoing. While it's not an impossible burden, there's morepaperwork than if you're a sole proprietor.
Taxes. LLCmembers pay self-employment taxes, the Medicare/Social Security taxpaid by entrepreneurs; it's calculated on 15.3 percent ofprofits. Contrast this with an S corporation: Self-employment taxis due on salary only, not your entire profits. You're caughtin the self-employment tax net if: 1) you participate in thebusiness for more than 500 hours during the LLC tax year; 2) youwork in a professional services LLC (health, law, engineering); or3) if you can sign contracts on behalf of the LLC.
Ultimately, the LLC decision is one you won't want to makealone. "Get advice from a specialist about the ideal corporateform to take," advises Seidel. "It can make a hugedifference later on." In business, as in life, one size rarelyfits all.
Joan E. Lisante is an attorney and freelance writer whofrequently writes about business issues.
