8 July 2022
TOPIC: Growing Your Firm
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In this blog, we are listing the pros and cons of opening an LLC. If you’re someone who is debating on opening an LLC, this is a blog you don’t want to miss!
What is an LLC?
LLC stands for Limited Liability Company. It is a type of business structure that provides limited liability to its owners.
The term “limited liability” basically means the owners of the LLC will not be held personally responsible for any debts or liabilities of the LLC.
If your LLC is sued for whatever reason, the owners do not risk losing their personal assets in the lawsuit.
Under state law, an LLC is not a corporation. Even so, it can utilize the many tax advantages corporations have under certain conditions.
Before LLCs were created in Wyoming in 1977, Americans
owned two kinds of businesses: a corporation or a partnership.
Corporations were subject to double taxation, owned by shareholders, had a board of directors, and followed rigid protocols.
Partnerships were business entities run by one or two people who were held personally liable for debts and liabilities of the partnership.
If Bob had a partnership and his company got sued, then Bob’s personal assets & investments would be at risk.
Many businesses were looking for a business structure with limited liability like corporations but more freedom like partnerships.
That is where the idea behind forming an LLC came about. Ever since the Hamilton Brothers adopted this LLC model in the 1970’s many businesses across the 50 states have followed suit as well.
What are the Pros of owning an LLC?
Compared to a corporation owning an LLC can be more beneficial for small business owners.
Here are some benefits of owning an LLC:
- Easy to form and maintain compared to corporations.
- Has limited liability similar to corporations
- You can choose how you want to be taxed.
- You can avoid double taxation.
Below we will go into detail on each one of these benefits.
Easy To Setup & Maintain
At the bare minimum, there are three things you need to do to create an LLC.
To form an LLC:
- You need a name
- You must file articles of organization
- You will need a registered agent
- (Possibly) An EIN or business license.
When you pick a name, you must ensure that it is not registered with the state already.
After that, you must file articles of organization with your state’s corporate filing office. These are documents needed to start your LLC and have it recognized by the state.
Finally, to complete the formation of your LLC, you need a registered agent.
This entity agrees to accept legal papers on behalf of the LLC if someone sues the company.
You can become a registered agent or have another company or person be registered instead.
Some states require an additional step where you need to obtain a business license EIN number.
When you have a corporation, you must have a board of directors.
That being said, changing members within your corporation is a more lengthy process than it is if you own an LLC.
Just like corporations, LLCs come with limited liability, which protects personal assets in case of being sued or in large business debt.
Choose How To Be Taxed
By default, when it comes to being taxed, you will either be treated like a partnership or a sole proprietorship. It all depends on if your business is co-owned or owned by a single person.
Now in terms of taxes, you can choose to be treated as a C-corporation or S-corporation.
Doing this will not change your business structure, and the IRS still won’t recognize your LLC as a separate entity.
However, how you pay taxes will be different if you change your LLC’s tax status to an S Corp or C Corp.
Avoid Being Taxed Twice
The one thing that really sets corporations and LLCs apart is how they are being taxed.
Corporations are usually taxed twice, once at the entity level and once at the shareholder level. However, by default, LLCs are only taxed once.
What are the Cons?
Here are some disadvantages of owning an LLC:
- You must comply with state regulations and fees
- Self-employment tax does apply
- It is not friendly toward investors
State Regulations & Fees
When you register your business as an LLC, you are a business recognized by the state. However, to complete this registration, you must comply with state laws and pay fees.
When you file your articles of organization with your state’s corporate filing office, you will have to pay a filing fee (usually around $100)
Several states require you to file an annual report with a filing fee. In some states (like California), these fees can be up to $800 a year.
If you own an LLC by yourself, then you are what we label as a sole proprietorship. Meaning you are the sole owner of the business.
As an owner, you are not considered an employee of your own business. Therefore, you will have to pay self-employment tax on your earnings from the business.
Since most multi-member LLCs are taxed as partnerships, most investors tend to shy away from becoming a member of businesses with this tax structure.
This is because partnerships do not share the same benefits compared to corporations.
Some investors cannot invest in LLCs because they have tax-exempt partners. Those partners do not want to receive active trade or business income due to their tax-exempt status.
Is Owning An LLC Worth It?
You don’t need an LLC or any formal business structure to start doing business tomorrow.
You can just be a sole proprietor and pay self-employment taxes. However, you will miss out on some key protection that owning an LLC can provide.
The two big benefits of LLCs are asset protection and not paying double taxes.
The first question you want to ask yourself is, do you have assets worth protecting?
Assets are considered things that you own and are fully paid off. Things like your car and house are considered assets once they are paid in full.
You might not want to open an LLC if you don’t have any assets currently. This is because you will be paying fees on something you can’t directly benefit from right now.
Not creating an LLC can prove to be very beneficial for people starting out who are not sure if their side gig will ever take off and become profitable.
You can be up and running without filling out documents or paying any fees. Depending on the state, you may not even need a business license.
However, once your business starts to grow, become profitable, and your income starts to rise, that’s when it might be a good idea to open an LLC.
Without limited liability, all your assets accumulated while in business are at risk, including your banking account.