For budding entrepreneurs, setting up their own business is both exciting and frightening. You’ll get to run your own business, calling all the shots. Still, you’ll need to shoulder the responsibilities that come with it.
One question will always linger in your mind: do I set up my LLC or not? The answer is yes—but maybe not for the reasons you think.
There are many benefits of starting your LLC, but there are also some drawbacks. This article will explore the pros and cons of setting up an LLC so you can decide if it is right for your business.
Limits Personal Liability
The first advantage of forming an LLC is that it limits personal liability. An individual who invests in a corporation or partnership has unlimited liability for all debts incurred by that entity.
A limited liability company offers protection from personal bankruptcy should the company fail because only the company’s assets are at risk, not those of its owners.
This means that your assets will still be yours even if your business goes belly up. However, you’ll have no excuse not to pay your financial obligations like previous personal debts, alimonies, or child support. In case you neglect your child support payments, you’ll need a child support attorney to help you negotiate terms with your former spouse.
Another major benefit to incorporating as an LLC is the savings you’ll have with your taxes. Corporate profits are taxed twice
- when the corporation earns and
- when the corporation distributes profits as dividends to shareholders who must pay taxes on them in their tax returns.
The federal and state governments do not tax LLC profits at the business level but only when the LLC distributes profits among members. This stipulation means that you’ll have to pay taxes on your share of LLC income when you file your individual 1040.
It’s important to note that some treat LLCs as “pass through” taxation entities, meaning profits are not taxed at the company level. Instead, the business reports all income and expenses on its tax return. It then passes through any net profits or losses to members, who report these items on their returns.
You’ll need an accountant to walk you through this process as it can be very complex. They can also help you determine the best way to distribute profits for tax purposes.
When it comes time to file your taxes, an LLC is usually treated as a sole proprietorship or partnership. This means that you’ll need to file form 1040 along with an informational schedule C (for business income).
However, some businesses choose to be taxed as C corporations. In this case, the company files form 1120 and pay corporate income taxes. You’ll then report your share of corporate profits or losses on Schedule E when you file your personal 1040 return.
Either way, it’s essential to work with an accountant who can help you navigate tax laws (and save you money!).
Although LLCs are great for protecting your assets and reducing taxes, they come with some downsides. For instance, if you want to raise capital or attract investors, it is harder for an LLC than a corporation.
Corporations can publicly sell shares of stock on the market; LLC members cannot sell their interest in the company without finding a buyer.
If you want to sell shares of your LLC, you’ll have to find someone who wants them, and there are often few takers because most people don’t want the hassle of being an LLC member.
An investor will take on significant risk by investing in an unproven business with no track record. For this reason, the LLC is usually a poor choice for raising capital.
Another drawback to forming an LLC is that it can make managing your business complex. A few guidelines in the law outline how many members an LLC must have and how it should distribute profits. However, keep in mind that these rules are not strictly enforced.
This means that it can be confusing to maintain and run an LLC without a clear understanding of how the business should be run. You’ll need to pay annual fees and file forms with your state, so it’s best if you have an attorney go over the necessary documents before you file them.
There are both advantages and disadvantages to forming your own LLC. Still, it’s undoubtedly a good choice for most new business owners. If you are looking to reduce taxes or protect your assets, an LLC will work well for you.
However, if you’re trying to raise capital or attract outside investors, an LLC isn’t the best option. Before making any decisions about what business structure you want, be sure to consult a lawyer and an accountant.