Small Business 101: Limited Liability Company

(Well, it’s another week here at the Amateur Financier, and that can mean only one thing: another edition of Investing Small Business 101.  This time we’re going to expand on some of the information you got back in the Corporations 101 article, and learn a bit more about one particular type of corporation, the limited liability company (or LLC).)

Q: What exactly is an LLC?

A: The IRS provides some basic information, telling us that the Limited Liability Company is a business form where ‘members’ (the owners of the company) have limited liability for the debts and actions of the LLC.  This means that if the business accrues a great deal of debt or runs into legal problems, the assets of the members can’t be taken to settle the company’s accounts.  This ‘limited liability is the primary driving force behind the creation of an LLC, in order for the members to keep their personal assets separate from the business and safe in case something unfortunate happens with the business venture.

Q: Aren’t those the same benefits as a regular corporation?  Why not just use a regular corporate structure to protect your assets?

A: Well, there are a few benefits of the LLC structure for the small business owner.  For example, while regular corporations are subject to double taxation on profits (once when the profit accrues to the business, and a second time when the profits are distributed to the shareholders), this is not always the case with an LLC.  The company could be structured as a corporation, a partnership or a sole proprietorship for tax purposes, allowing the owners of the LLC to avoid double taxation (what is known as ‘pass-through’ taxation on the company’s income).

Furthermore, while a corporation has a rigid structure that needs to be followed in order to maintain the status of the corporation, a limit liability company can be much more flexible in its structuring.  Rather than needing a corporate structure involving officers and a board of directors, an LLC can have almost any structure that the owner needs, from a single owner to as many members as corporate requirements dictate.

Q: With all the advantages that LLCs offer, why don’t all corporations incorporate under that form?

A: While there are many advantages to LLCs, there are a few reasons to opt for a traditional corporate structure instead.  Chief among these is that a corporation (which can come in several different forms that we will cover in the future) can go public (issue shares of stock to interested investors, employees, and board members).  If your company is likely to go public in the near future, an LLC structure is not for you.

Furthermore, the rules for LLCs differs more from state to state than do the rules for traditional corporations.  If your business spreads (or is likely to spread) across state lines, using a corporate structure rather than an LLC is one way to limit the paperwork, regulatory headaches, and differing tax structures present throughout the United States.  These reasons make a corporation more useful than an LLC for large or rapidly expanding companies.

Q: Alright, so I have a small business I’d like to turn into an LLC; how do I do it?

A: Because the rules for an LLC differ depending on the state, it’s hard to provide a simple, firm answer to the steps you need to follow.  The IRS, for example, does not recognize limited liability companies as a tax classification, so you will need to designate your LLC as a corporation, partnership, or sole proprietorship using form 8832.  You will also need to determine what other requirements, if any, your state has for LLCs; a good place to start your search is on Bankrate’s small business page.

Q: Any last comments on LLCs?

A: Unfortunately, we seem to living in increasing litigious times, when many people seem more likely to call a lawyer with the slightest provocation.  As such, having some way to keep your personal assets safe should your business ventures run afoul becomes vital.  Limited Liability Companies represent one (although far from the only) method of doing so, and are worth considering for a great variety of people who lead public lives.

That’s it for now; have a good day, and for those of your with an entrepreneurial bent, consider LLCs as one way to structure your business.

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