Pros and Cons of a Limited Liability Company (LLC)
A limited liability company is a hybrid business entity that combines elements of a corporation and a partnership. All states have their own laws regarding the formation of an LLC, but the following are general pro's and con's unique to most LLCs:
Advantages of an LLC
- LLCs may be formed by a one or multiple persons, who don't need to be U.S. citizens or residents. Members can be a part of other business entities, including corporations, LLCs or foreign entities.
- The management structure of an LLC does not require a board of directors, thus it allows the members to self manage the business. All members may be involved in the day to day management of the business unless the operating agreement specifies that the entity will be managed by managers.
- An LLC can choose to structure itself like a corporation and elect a board of directors and officers and follow other corporate formalities.
- LLC owners are allowed to pass profits and losses to their personal tax returns instead of filing a company tax return.
- By default, LLCs with just one member are taxed as a sole proprietorship.
- By default, limited liability companies with multiple members are treated by the IRS as partnerships.
- An LLC may elect to be taxed as a corporation.
- The LLC itself does not pay taxes, nor is it required to file an income tax return, although an information return must be prepared.
- Members of an LLC have personal liability protection from business creditor claims (with the exception of certain types of fraud and misrepresentation).
- LLCs require less record keeping and paper work than a corporation, do not require annual meetings and are ultimately an easier business entity for a single person to manage.
Disadvantages of an LLC
- In many states, professionals such as attorneys, accountants, architects, doctors, chiropractors and engineers cannot operate in an LLC and alternatively can organize as a Professional Limited Liability Company.
- Some states do not allow a single member LLC.
- An LLC has no retained earnings, so any profits at the end of the entity’s fiscal year must be distributed to its members.
- Single and multi-member LLCs that are not electing S or C status must pay self-employment tax.
- Raising outside capital from angel investors and venture capital firms is much more difficult.
- LLCs do not have stock option plans.
An LLC is a newer form of business entity that in recent years has become increasingly popular throughout the world. Its main draw is the fact that the liability of its owners for the debts and obligations of the business is limited to the owners’ financial investment. By default, LLC’s are taxed as sole proprietorships or partnerships (both pass through entities), are relatively easy and inexpensive to form, and require less record keeping and paperwork than a traditional corporation.
Photo courtesy of misc hiru via Flickr