If you start a business, you may find your legal or financial advisor recommending that you incorporate the business as a limited liability company. LLCs provide you with legal and tax advantages. An LLC also generates disadvantages in terms of how you receive payments and, depending on your record keeping, what legal protections you enjoy.
Limits Your Liability
Both single-member and multi-member LLCs protect the personal assets of the owner or owners of the business. Only the assets of the LLC itself can be seized in the event of debt collection or, in some cases, lawsuits. For example, if your LLC takes out a $5,000 loan to purchase inventory and the business fails, the bank cannot seize your personal vehicle to recoup its losses. It can only seize the leftover inventory, cash and other assets controlled by the LLC.
Limited Single-member LLC Liability Protection
In the case of single-owner LLCs, the liability protection offered by the LLC form does not always extend to lawsuits. If you don’t maintain the LLC as a distinct entity from your personal finances, and don't keep separate records, a court may decide you are personally liable in a lawsuit.
In large corporations, the corporation pays federal taxes on its taxable income and all employees also pay taxes on their incomes. An LLC does not file a separate tax return, which lets you avoid this double taxation. Instead, profits “pass through” the corporation directly into the hands of LLC members. The members then file either a profit or loss on their personal taxes. If you run a single-member LLC, you file taxes as a sole proprietor. If you work as the managing member of the LLC, the government also permits you to write off all health insurance premiums, up to the limit of your share of the LLCs profits.
Regardless of whether you -- or another member -- actually receive any money from the LLC, you remain responsible for the taxes on your share of the LLC's profits. If you act as the managing member or run a single-member LLC, you must also pay self-employment taxes on your share of the profits. You must make quarterly, estimated self-employment tax payments. Unlike the federal government, some state governments require LLCs to pay taxes.
LLC members can opt to receive payments in two main ways. You might write yourself a check drawing on the funds available to the LLC, called a distribution. A member may also receive “guaranteed payments,” or payments made on a regular basis for services rendered.
You cannot receive a wage from an LLC the way a regular employer pays employees. To receive payments on a fixed schedule, as you might receive a wage, you must establish a program of guaranteed payments.