Forming a business is an exciting venture. You have talents, skills, and an entrepreneurial spirit. Now, all you need to decide is this: should your business become an LLC or some other type of company? First, you need to know what a limited liability company is and its advantages and disadvantages. Comparing it to other business structures is also essential.
You have to think about things like taxes and hiring an accountant. Or you could set up and use QuickBooks to manage your sales tax, bookkeeping, and accounting functions. The most important place to start is deciding whether your business should become an LLC.
What is an LLC?
For small business owners, LLC owners, and all other types of business owner, you’ll need to understand just what an LLC is to know if it’s right for you and your business. An LLC is also known as a limited liability company. If someone sues you, it is the limited liability company that would have to pay damages. If your business fails, the LLC might declare bankruptcy. None of this would affect your personal finances.
An LLC is often called “a pass-through business.” That means the profits and losses are passed through from the company to your personal income. Yet, you don’t have to pay corporate tax. You do have to pay self-employment taxes, which you should send in quarterly. It’s always best to consult a lawyer when drawing up an LLC or any other type of business. Also, it never hurts to read articles on tax tips for your LLC.
If your company has significant risk to your personal assets, an LLC can mitigate that risk. You can start a limited liability company relatively easily. Moreover, the cost of setting up the business structure is low. With an LLC, the owners have personal liability protection. These three things make an LLC attractive to small business owners.
What Are Other Common Business Structures?
LLC is only one type of corporation. There are many other ways to make your business official. However, before you choose, take some time to study how the structures work and what they will mean to you at tax time. One way to do this is to read articles online, such as guides to small business tax credits and other financial topics.
To get the ball rolling, here are some business structures you could choose for your small business:
Partnership
If you want to build a business with two or more people, consider a partnership. It’s the most uncomplicated business structure to set up and run for one owner. You can choose either a limited partnership or a limited liability partnership.
In a limited partnership, one owner has unlimited liability. The other owner or owners only have limited liability. The owner with unlimited liability has more control over the company than the other owners. This first owner is responsible for filing self-employment taxes. These duties are generally laid out in the partnership documents. Income passes through from the business to the personal taxes for each partner.
In limited liability partnerships, every owner has limited liability. All the partners are protected to a certain extent; they aren’t responsible for the business’s debts, and if one of the partners makes a poor legal or operational decision, the other partners are not held accountable.
Many small businesses choose the partnership when more than one person owns the company. Lawyers can benefit from having an LLC, and it’s a useful business structure for people who aren’t yet sure where the business idea’s success will go.
Corporation
Corporations make sense for companies with high or moderate risk. Banks are usually happier to lend to a small corporation than a pass-through business like an LLC or an S-corp. A C corp can also be sold and still continue operating after the original owners move on to another venture or retire.
In a corporation, the business is separate from all the owners. This separation applies to taxes, liability, and responsibilities. A corporation is more expensive to set up than other types of businesses. A corporation can also continue operating after one of the owners leaves the company. That means it will continue even after the original owners retire.
The business pays the taxes, not each of the individuals. The owners pay their personal taxes, including any distributions from the corporation. However, the corporation files its own taxes based on the business’s profits and losses. Corporations also might have double tax duties. That is, the profits are taxed within the company and on the shareholders’ personal taxes.
In a corporation–also known as a C corp–it’s essential to understand the ins and outs of small business deductions and credits. Even though you will likely work with an accountant, you need to be familiar enough with the tax code for small businesses that you can be sure everything is recorded as it should be for a corporation. Knowing about taxes can also be beneficial when it’s time to make business decisions.
Corporations require more effort and paperwork. Not only that, but you will have more decisions to make at the beginning. You need to put together a board of directors who are elected. You must write by-laws, produce formal financial statements, and focus more on keeping records for the C corp. The paperwork can be burdensome. In the end, a corporation is usually the way to go for certain moderate to very risky businesses.
S Corporation
In some ways, an S corporation–or S corp–is like an LLC. Both use pass-through taxation. Both offer limited liability to the owners, and they may have to file reports or pay extra fees. However, S corps differ from LLCs in several ways. An LLC can avoid many of the formal requirements of an S corp. Shareholders in an S corporation can give or sell their stock to other members of the corporation.
Although an S corp is a type of corporation, it differs from a C corporation in that profits can be passed to the individual owners. Taxes are handled differently–for instance, the double taxation of a C corporation doesn’t happen in most S corps.
However, just like a C corp, the owners must file according to strict IRS rules and keep track of more exacting requirements for operations. Also, in an S corp, the owners can leave or sell their interest in the business to someone, and the corporation keeps going.
Because of the tax advantages of an S corporation, it’s often chosen over a C corp. One thing you must remember when making your choice is that there are strict eligibility rules for an S corp. You can find these rules and file with the IRS to see if you meet them.
B Corporation
A B corporation, also known as a benefit corporation, is a company that is taxed like a C corp. B corps have a mission, but they are also intended to make a profit. They must be transparent, pursue their purpose, and have strict accounting rules and responsibilities. In this way, B corps are different from C corps. Yet, the C and B corps are the same in most other ways.
A B corp must provide some benefit to the public and show that this is happening through specific types of reporting. It’s important to know that not all states allow B corps, so you should check before you decide which form your business will take.
Close Corporation
A close corporation has similarities to a B corp. They have fewer rules and a nontraditional structure. In most states, the shareholders can run the business and do not need a board of directors.
Nonprofit Corporation
Nonprofit corporations are set up to benefit some public needs. Here are some of the causes a nonprofit can aim to help the public through their company:
- Charity
- Education
- Literary
- Religious
- Science
Also called a 501(c)(3), a nonprofit must follow strict rules, especially regarding fulfilling the corporation’s mission and proper handling of any profits. They can only work towards certain goals, while other goals are off-limits, such as giving profits to a political cause. You must file with the IRS to get approval to form a nonprofit.
The Advantages of Becoming an LLC
If you’re thinking of forming a business, consider the advantages of becoming an LLC:
- It’s easier to set up an LLC with fewer requirements
- Less paperwork
- Owners can choose which type of taxation they want; as a sole proprietor, a partner, or a corporation
- The LLC does not pay corporate taxes
- LLCs aren’t subject to double taxation
- Fewer rules govern LLCs
- They don’t pay any unemployment tax
- LLCs have pass-through income that you can take more often than a corporation
The Disadvantages of Becoming an LLC
LLCs aren’t always the best choice for every small business. They do have a few disadvantages. Here are some of the most common ones:
- LLC members must pay self-employment taxes
- LLCs can sometimes be forced to dissolve, leaving members vulnerable to debts and other risks
- An LLC may be automatically dissolved if they fail to report on time, a member dies or withdraws, or a structural change, such as a merger
- Some terms of an LLC might expire
- Because states are in charge of regulating LLCs, keeping track of the state rules is hard, especially if you operate in more than one state
- It can be too easy to mix personal business and income, which can lead to bookkeeping problems
How to Form an LLC
Forming an LLC, as mentioned before, is one of the easiest ways to set up a company. First, you need a name that another business has not registered. The name must end with “LLC” or “Limited Liability Company.”
Next, you need to set out your rules and relationships in a document called “Articles of Organization.” This document doesn’t need to be elaborate, but it should contain all the essential information about your LLC, how members will contribute, and how the LLC will operate. All members of your LLC must sign this paperwork.
At this point, you need a registered agent who will handle your company’s legal documents. Usually, the registered agent is an LLC member. Of course, there are registration fees you must pay the state, which you must pay to become an LLC.
In some states, you will be required to publish a Notice of Intent so that the public knows you are starting a business.
Finally, you must create an operating agreement if your state requires it. Yet, even if your state doesn’t demand it, an operating agreement can help you avoid clashes between LLC members. After all, the document lays out what every member is required to handle and what they get as a member.
After doing all the above, your LLC is ready to work. However, don’t neglect to have a meeting with a small business tax consultant. They can get you up to speed with all the tax credits and deductions and how they work. This discussion is essential because it will help you prepare to keep your taxes as low as possible.
The Bottom Line
After getting some information on various business structures, it’s time to answer the question: Should your business become an LLC? The truth is that every type of business structure works for someone. Otherwise, all these options wouldn’t exist.
Remember, the question is what you should do, not what is best for everyone. Therefore, you need to contemplate the subject of structure seriously. Consider the following:
- How much risk is there in your industry or occupation?
- How much effort do you want to put into setting up your business?
- Do you want a more formal structure than an LLC provides?
- How many members will be owners of the company?
- Do you prefer pass-through income, or would you instead want to get periodic dividends?
- Are you willing to do or hire out the work of a strict accounting and reporting requirement?
- How many employees will you have?
- Can you accept paying self-employment taxes?
- Do you want to avoid double taxation?
- How much do you know about tax programs that could benefit your small business, such as bonus depreciation?
When you can answer these questions, you will begin to see whether a limited liability company is right for your business. If you have other members, sit down and talk with them about the options and requirements for each one.
Don’t proceed until you have settled any disagreements and set your intentions and plans. Remember, LLCs aren’t suitable for everyone, but you should consider the pros and cons carefully before you start filing paperwork. An LLC may be just the best business structure to start you on a path to business success.
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