Why Do I Need an LLC?

by Madison Garcia; Updated September 26, 2017
Desktop PC with files stacked next to the monitor

Business owners have a variety of business entities to choose from, each of which offers specific benefits. A limited liability company offers its members the taxation benefits of a partnership or S corporation with the liability protection of a C corporation. LLCs are a frequent choice for business entity because they are inexpensive to set up and simple to maintain, and they offer flexibility in profit sharing.

Limited Liability Protects You

Compared with other legal entities, such as sole proprietorships, general partnerships and limited partnerships, an LLC offers more protection. In an LLC, all members are insulated from personal liability regarding business matters. While members are still liable for fraudulent and illegal acts they commit, they're not liable for LLC debts or for decisions made by company representatives. If your LLC goes broke, creditors can't come after your personal assets to settle the debt. Likewise, if the company is sued for negligence, your assets are protected.

You Avoid Double Taxation

Small businesses commonly avoid incorporating because of the dreaded "double taxation." When corporation shareholders want to get money out of the company, their only options are salaries and dividends. Dividends are paid out of retained earnings, which means they're not technically an expense, and the company gets no tax deduction for it. However, the shareholders still have to pay tax on dividends received.

In contrast, an LLC can elect to be taxed as a pass-through entity. The LLC itself doesn't pay income tax; instead, it passes profits and losses through to members. This means that company earnings are taxed only once on the member's tax return. If the LLC member is actively participating in the business, these earnings are classified as ordinary income. For passive LLC investors, the earnings are taxed at capital gain rates. If the LLC has a net loss for the year, the member can use that loss to offset personal income and lower total tax liability.

Profit Sharing Is Flexible

The ability to offset personal income with business losses is one of the prime advantages of a pass-through entity. However, this tax benefit only works if the LLC member has income to offset. If you don't earn money elsewhere, you can't take full advantage of the business losses.

One way to solve this issue is to change the percentage of losses each member receives to maximize tax benefits. Members of partnerships and S corporations must take the same percentage of profits and losses. An LLC allows its members to allocate profits and losses however they want. For example, an LLC allows two members to split profits equally but allocate more losses to one.

Company Organization Is Simpler

To form an LLC, you must file articles of organization with your state and pay a filing fee, but the time and money to maintain an LLC is much less than it is for an S or C corporation. Corporations must not only file articles of incorporation but also write bylaws, elect corporate officers and authorize classes of stock. Both S corporations and C corporations must establish a shareholder-elected board of directors that meets on an regular basis and manages the company's executives. LLCs, on the other hand, do not need to elect a board of directors.

About the Author

Based in San Diego, Calif., Madison Garcia is a writer specializing in business topics. Garcia received her Master of Science in accountancy from San Diego State University.

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