Biz Formation: Limited Liability Companies

We discussed the simplest business form, the Sole Proprietorship, and now we're back to discuss another type, the Limited Liability Company (LLC). This biz type is a little harder to set up but has certain benefits not available to Sole Proprietors. Mostly involving tax and liability...WAIT! DON'T LEAVE! This is valuable info for you and your business so stick with me here!

Ok, glad you made it this far. As a general overview of the LLC business form, remember that you are getting a sort of combo of other business forms. You get taxed like you would as a sole proprietor combined with the limited liability protections of a corporation. Let's dig in on the details of what this means and whether it's a good fit for you and your business.

Taxation
Let's get this bad boy out of the way first. As the owner of an LLC you can decide if you want to get taxed as a pass-through entity (like a sole proprietorship) or as a regular C Corporation. If it's taxed as a pass-through entity, it means the company itself doesn't have to pay the taxes but instead, it passes through to be reported on the LLC members' individual tax returns. If there is only one member of the LLC, this will look identical to a sole proprietorship. The member's profits, losses and deductions are reported on his or her own Schedule C.

If there are two or more members, each year it must prepare and file an IRS Form 1065 (the same form that is used by partnerships), showing the profits, losses, credits and deductions passed through to the members. In addition, the LLC must distribute a Schedule K-1 form to each member which shows the members' allocations.

Liability Issues
Your "limited liability" for an LLC is the same as if you were to form a corporation. This means members (or shareholders for a corporation) are not personally liable for the debts of the corporation or lawsuits. Remember that these liability protections have limits and might not shield you as much as you might think. For example, major creditors, such as banks, are usually not going to let you avoid personal liability by incorporating - instead they will likely demand you personally guarantee any business loans. Same goes for something like the lease of office space. In contrast, it will probably shield you from smaller transactions like office supply purchases.

It's a similar case for members' personal liability for lawsuits. The members will still be personally liable for any damages caused by their own negligence or intentional wrongdoing in carrying out corporation business. What does this mean? If you form a corporation that doesn't have money or adequate insurance to pay a claim against it you can bet the attorneys are going to find a way to hold you personally liable.

So to sum it up:

• The good:
  
  • LLCs are simpler and easier to run than a corporation (although it takes about the same amount of time and money to set it up)
    
  • Avoid state and federal unemployment taxes (like a sole proprietorship)
    
  • Limit your personal liability
    
• The bad:
  • LLC members who actively manage the biz must pay self-employment tax on all income received from the LLC
    
  • Your personal liability isn't protected as much as you would think (but there is insurance to help cover you).
    
  • Harder to set up than a sole-proprietorship
    

I hope this gives you a general overview of what a Limited Liability Company is. We're going to dig in deeper with comparisons between all the different types of businesses in future posts!