Are you running some sort of business outside your normal employment or are you self employed? Do you have investments that involve active participation, like real estate? Then you should definitely explore the benefits of forming a limited liability company.
Top 5 Advantages of Forming an LLC
Limited Personal Liability
Flexible Ownership Structure
Fewer Formalities and Paperwork
Separation of Personal and Business Assets
Let’s say you own a piece of multifamily real estate, like a small apartment complex. One frigid winter day, a tenant slips and falls on a patch of sidewalk that your maintenance crew forgot to salt the night before. Now, this disgruntled tenant has decided to sue you, as the owner, targeting your personal assets. This is a classic case where you should have separated yourself and your personal assets from the assets of your business in order to avoid personal liability.
Or let’s say you offer consulting services to small business owners in the restaurant industry. Nothing there for anyone to trip, slip, or fall on, right? But let’s say one client has an absolutely disastrous experience implementing your advice, resulting in substantial monetary loss. Can they sue you and your own personal assets to recoup their losses?
If your business structure is set up as an LLC, the chances of that coming to fruition are far less likely.
What is an LLC?
An LLC is the American form of a private limited company. A public company, as opposed to a limited company, issues shares of stock (ownership) that can be publicly traded on a marketplace whereas a limited company does not.
An LLC blends the advantages (and disadvantages) of a corporation and a sole proprietorship or partnership. Like a corporation, the business becomes a separate entity for most purposes. But like a sole proprietorship or partnership, the taxes of the business are synonymous with the owner or owners of the business.
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Top 5 LLC Advantages
There are many benefits to forming an LLC, our top 5 listed above are discussed below:
1. Limited Personal Liability
The main and immediate benefit of forming an LLC is that it separates your personal assets from the business, making it much more difficult for someone negatively impacted by your business operations to target your personal assets, like your cash, home, car, or anything else you own.
They will have recourse to business funds and assets, but that beats losing your personal residence or bank account in a lawsuit. Limited liability companies award this type of limited liability protection to the owners of a business, whether they have a rental property portfolio or if they are a small business owner selling pocket-sized electronics on Amazon.
A related component to the protection a sole proprietor or business partners see as an LLC member is that creditors cannot target personal assets in order to recoup losses from unpaid business debt. This is particularly beneficial when it comes to asset protection because most business ventures at some point will need to utilize debt for economic growth.
Sometimes a business does not make it and creditors are looking to recoup their losses. If a business entity is separate from the LLC owner in terms of assets and debts, then creditors cannot move against the owner to recover defaulted business loans.
2. Pass-through Taxation
When it comes to filing taxes, an LLC is a disregarded entity. This means that business profits and losses go on your personal Form 1040 income tax return, and you do not need to file a separate corporate tax return. This makes filing your taxes much easier, and it also means that there will be no federal taxes on your business income at the corporate rate.
However, there may be other disadvantages that become applicable based on how much you are earning, such as the near 15 percent self employment tax rate.
This 15 percent tax rate (FICA taxes) goes toward earned income funds programs, like Medicare and Social Security. For employed individuals collecting paycheck wages, the company that employs them pays around half that, while the other half comes out of the paycheck. But since a self employed individual writes their own paycheck, they have to shoulder FICA taxes in addition to the income taxes that are applied to their earnings. There is a way around this, but it involves creating an S corporation.
For more information about S corporations and other business structures, sign up for our Structure Implementation Series.
3. Flexible Ownership Structure
An LLC has a fairly flexible ownership structure. You can be the sole owner, or you can have partners. You can also appoint someone outside the business to run the business without needing to make them part of the business.
Keep in mind that whether an LLC is a single member LLC or a multi member LLC, all the profits are allocated according to the ownership structure. If there are two members, the profits will be split 50-50 unless some sort of alternate payment structure is indicated.
For tax purposes, this means there is not really any way to make the 15 percent FICA tax disappear, even if it’s split up among multiple parties. However, in terms of ownership structure, the LLC is very versatile because people outside the LLC can be brought in to help run the business without becoming part of the LLC on paper.
4. Less Formalities and Paperwork
There are going to be less formalities and paperwork for an LLC, which means less headaches and less expenses if you are paying someone to manage it for you.
Keep in mind, however, that the liability protection afforded by an LLC may be removed by a judge in rare instances (also known as piercing the corporate veil). Though it really all is just on paper, that paper must carry weight in terms of separating a business owner from their LLC.
5. Separation of Personal and Business Assets
Another great benefit to forming an LLC goes beyond the separation of assets to protect you from liability, and enters the realm of better accounting practices that make running your business easier.
For starters, having a separate checking account and credit card for incidental and regular business expenses (inventory, contracting, travel), and make it much easier to keep a running tally of profits and losses. Moreover, the internal revenue service needs to see that you actually are operating your LLC as a separate enterprise if you are going to enjoy the tax benefits and liability protection it affords.
These tax advantages can be used on your federal income tax return and your state income tax return. And if you currently utilize Anderson Advisor’s registered agent and corporate concierge services, these expenses can be written off as well.
What Types of Businesses Should Choose an LLC?
Almost any type of business owner can benefit from forming an LLC around their activities, even if only for the purpose of reducing their liability and risk. However, as mentioned, an LLC is a pass through entity when it comes to taxes, which could result in paying the self employed tax rate.
In some instances, it may be more beneficial to set up a corporation, put yourself on a payroll, and pay a lower amount of FICA taxes on your own wages. This can get complicated, and the effectiveness of such a plan involves a variety of factors, so it’s good to run it by a tax advisor or accountant who is familiar with your business.
If you are not necessarily self employed in the sense of providing goods or services, but you own investments like stocks, bonds, or real estate, it’s also a good idea to consider forming an LLC. One reason is that forming an LLC can provide tax advantages for these activities. For instance, if you buy and sell stocks, but have not obtained day trader tax status, you can’t write off losses or investments from your trading business (such as a computer, software to analyze the market, subscriptions, and/or seminars). Forming an LLC around your trading activity allows you to write off these expenses and others, even if you are not fully considered a day trader by the IRS.
In some states, such as Texas, if your business involves providing professional services (such as medicine and law) you may be required to set up a PLLC—professional limited liability company. In most cases, a PLLC is the same as the LLC, but one key difference lies in the area of malpractice. In a PLLC, one partner cannot be held personally liable for the malpractice of the other—for instance, one doctor cannot be sued because of the actions of another doctor in their shared clinic. However, a partner can be personally held liable for their own malpractice—such as the case of an architect who designs a faulty building. This reduced scope of personal liability protection obviously makes this type of business structure different than an LLC, but it also (arguably) forces professionals in serious fiduciary or sensitive roles to be held accountable for the performance of tasks that require professionalism and careful skill.
In other instances, you may find setting up an LLP to be more beneficial. To briefly explain LLP vs LLC advantages, a limited liability partnership is similar to an LLC in that it provides legal protection and risk management, but it differs in the fact that it’s specifically geared toward formalizing an agreement between several business partners. In an LLP, or limited liability partnership, partners can come and go in the business, sharing business assets and resources, but each and every partner is personally protected in terms of liability.
An LLP should not be confused with a limited partnership, which is a different type of structure. An LP restricts the ability of partners to actively manage the business. For instance, if you are a real estate investor and need other people’s money (OMP) to flip homes or invest in multifamily units, you probably don’t want your business partners/investor telling you how to run the business. An LP can facilitate independence in terms of managing the business.
There Are Many Advantages to Setting Up an LLC
When it comes to running a business or managing investments, setting up an LLC provides several advantages—reducing your personal liability and securing favorable tax benefits are two of the biggest.
There are many steps involved in correctly forming an LLC. Working with a tax advisor or lawyer who understands the process can go a long way toward keeping your business compliant and in good standing. Schedule a consultation today to get a free entity formation blueprint and learn more about the many ways an LLC can be advantageous for your business.
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