Is an LLC the right tax structure for my business?

As we highlighted in part one of our series on sole proprietorships, entrepreneurs should consider the specifics of their business today and where they want to take it tomorrow when choosing a tax structure. In addition, the type of business and planned ownership structure should be considered.

What is an LLC?

A limited liability company is a flexible business entity that provides the simplicity of partnership while extending the tax benefits and personal asset protection of corporate structures.Although LLCs are often referred to as limited liability corporations, this is a misnomer. Technically LLCs are not incorporated and should be referred to as a limited liability company. LLC structures are permitted in a majority of United States jurisdictions. In 24 of the 50 states LLCs are not required to organize for profit pursuant to the Model Business Corporation Act of 1950.

Key points of an LLC structure

Asset protection - An LLC provides protection to members by limiting their personal financial liability against company debts. In the event the business cannot pay its debts, personal assets of its members are protected. 

Tort protection - Limited liability usually protects owners and investors against litigation. If a lawsuit is brought it is filed against the “company”, not members thus again protecting personal assets.

Initial investment - Generally, the liability of members is a fixed amount and corresponds with the capital invested. If the business has no profit and has paid no dividends, personal liability would be zero, regardless of outstanding debts or judgments.

Exceptions of personal liability under an LLC structure

If a member makes a personal guarantee of a loan for the LLC, (co-signing) they may be liable for the debt.

If the LLC fails to acquire insurance or has minimal capitalization, members could be liable.

If personal funds are co-mingled with LLC funds, such as using one bank account for both personal and business expenditures.

If the LLC violates any state laws or fails to pay state taxes, members could be personally liable for debts.

The pros of an LLC structure

Access to capital - An LLC can sell membership interests and create different tiers of membership with different investment requirements, voting privileges or profit characteristics. Venture capitalists are more willing to invest in LLCs vs. a sole proprietorship or general partnership because they are only risking the initial capital investment and have protection against seizure of their personal assets.

Ownership and interests transfers - An LLC can be transferred or sold in whole or in part with out interruption of business continuity. Bank accounts, licenses, permits, tax identification numbers and various assets can be transferred to the new ownership or interests.

With a sole proprietorship or general partnership each asset must be transferred separately and new accounts, licenses, permits and tax IDs must be acquired. 

Cons of an LLC structure

Set up costs - LLC’s allow a less formal structure than corporations but require more organization than sole proprietorships or partnerships. LLC’s have greater set up costs and fees, filing fees and annual state fees. However, LLC’s enjoy lower insurance rates than other structures, which help mitigate annual fees. 

Record Keeping - In addition to a more formal structure LLC’s must keep business records separate from member’s personal records. LLC’s must file a separate tax return whereas sole proprietorship owners can include business income on their personal 1040 schedule C tax return. As stated above co-mingling of personal and business accounts could result in revocation of liability protections by offending members of the LLC.

When starting a new venture entrepreneurs will benefit from examining the various aspects of each business entity type. For some businesses a sole proprietorship is just fine, for others an LLC is a safer bet. It’s a good idea to get some expert advice on the ins and outs and pros and cons of each structure in relation to your business. 

Tom Bulger, CPA has a wealth of knowledge, expertise and experience helping entrepreneurs choose the right business model to launch their dreams. Contact Tom Bulger for answers to all your start-up questions.

Have you recently expanded from a sole proprietorship to an LLC? How was the process? Did it improve access to capital? Do you have greater piece of mind knowing your assets are protected? Share your comments below.

Check back for the next post in our series on business entity tax structures. We will cover partnerships; limited liability and general, and begin looking into corporations.

Posted on April 19, 2013 and filed under Small Business Success.