Last Updated: August 31, 2021
A limited liability company (LLC) is a popular choice among business owners. The most significant benefits of an LLC stem from its hybrid structure, combining the taxation model of a partnership (or sole proprietorship) with the legal liability of a corporation.
But to fully appreciate the LLC advantages, you should first understand the concept and compare it to alternatives.
So, let’s dig a little further!
What Is an LLC?
An LLC is a US-specific legal status of a commercial entity. Shareholders or owners are referred to as members. They enjoy limited personal liability for business debts and claims, which is arguably the main LLC benefit. In terms of taxes, the Internal Revenue System (IRS) most often treats LLCs like sole proprietorships or partnerships, depending on the number of members.
The most common alternatives to the LLC business structure are:
- Sole proprietorship
- General partnership
- Limited partnership
Each of these options has its own set of advantages and disadvantages. So understanding each specific structure is essential for comparing and outlining the benefits of starting an LLC. The size or the ownership structure of an enterprise may rule out some options, but there’s always a choice. Some entrepreneurs handle this by looking for a specialized LLC services agency to take on the administrative task in their stead.
When running a sole proprietorship, your physical address is basically the contact address of your proprietorship. And when it comes to an LLC, you need a registered agent. This is a person or an agency that receives documents on behalf of your business.
While you could, in theory, list yourself as a registered agent, there are numerous difficulties and reasons why this is a bad idea. In general, to enjoy as many LLC benefits as possible, you need to take a less active part in the company management.
Benefits of getting a registered agent (as opposed to registering yourself) are:
- Higher level of privacy
- No need to update information after a personal address change
- Running a business in multiple states (you would need an address in each)
- Handing over another administrative task to someone else
Keep in mind that appointing a registered agent is a vital step and that failing to do so may result in your business being legally dissolved. Before you focus on the LLC benefits, you need to ensure that you’ve honored a proper legal form. In a scenario where you don’t have anyone trustworthy enough for this task, you can outsource this role to a professional registered agent service.
Why Set up an LLC?
The most obvious reason to set up an LLC is to create a legal separation between you as an owner and the business. This way, you won’t be liable for any debts incurred by your entity or most business-related lawsuits.
For example, there’s no separation between the entity and the owner in the case of a sole proprietorship. In practice, this means that you may end up losing your personal assets (home, vehicle, family heirloom) if the business goes south.
The other reasons to run your business as an LLC are basically what could be considered the limited liability company benefits. But before we focus on them, let’s look into the alternatives.
Types of Business Entities in the USA
The type of business entity determines the ownership structure of the business, the tax scheme, and many other relevant factors.
We’ve grouped all types of legal entities in the US into five categories so that you can compare them to the LLC structure.
A sole proprietor or a sole trader is the simplest type of unincorporated business entity out there. The benefits of a sole proprietorship are that registering is cheap (as little as $26), there are no annual fees, and paying taxes is as simple as it gets. You don’t even have to keep separate books for you and your business.
Still, there are some benefits of the LLC structure, even if you are a sole owner. Mainly, the limited liability. An LLC protects its owner from business-incurred debts and external lawsuits, whereas, in a sole proprietorship, creditors can get compensated from the owners’ personal assets.
In the past, double taxation was one of the biggest disadvantages of an LLC, and it was something that you could avoid as a sole proprietor. Today, LLCs can also steer clear of double taxation by choosing to be treated as a partnership or a sole proprietorship.
This is only a brief rundown of the sole proprietorship vs LLC comparison. If you’re on the fence between the two, consider all pros and cons relevant in your specific situation.
A partnership is an arrangement between two or more parties. In terms of a business structure, it’s an arrangement between two or several parties to operate a business together and share its profits. Two common types of partnership are:
- General partnership company
- Limited liability partnership (LLP)
The general partnership company is a simple arrangement where both sides agree to share the profits and liabilities of a company.
An LLP, on the other hand, is a partnership with numerous benefits of an LLC. Here, partners can make such a legal arrangement so that one partner is not liable for the misconduct or negligence of another. As a result, the LLP vs LLC can sometimes be quite a dilemma.
We’ve already covered the basic definition of a limited liability company. But that’s just the tip of the iceberg.
The biggest challenge in understanding LLC advantages lies in the fact that LLC laws vary by state. The same goes for annual LLC fees, which range from $0 in Ohio (and some other states) all the way to $800 in California.
There are many different types of LLCs, which differ in taxation, organization, and even liability. These are:
- Single-member LLC
- General partnership
- Family limited partnership
- Series LLC
- Restricted LLC
- L3C Company
- Anonymous LLC
- Member-managed LLC (Manager-managed LLC)
In many scenarios, certain structures can provide advantages of an LLC to specialists in specific industries. At other times, it comes to particular circumstances.
For instance, the family limited partnership allows simple transfer of power and ownership to relatives, making it ideal for family businesses. Also, structures like series LLCs allow for higher membership segregation of interests, assets, and operation interests into series (hence the name). Unfortunately, series LLCs are only available in the following states:
In other words, some options may be a perfect fit for your situation, while others may not be available in your state (or in your case). You should consider these restrictions and make an informed decision based on your individual needs and circumstances.
The next item worth discussing is the benefits of a corporation over an LLC and the other way around. The former is a legal entity that exists completely independently from its owners. As such, this entity can be held legally liable, taxed, and make a profit. In terms of protection from personal liability, the corporation is at the very top of the list.
But with a corporation, there’s the double taxation issue. As we’ve already said, a corporation is a separate entity that can be taxed independently. This means that both the corporation and the individual shareholders get taxed for the same profit.
The biggest advantage of an LLC over a corporation is that you can get some of this liability protection without having to undergo the entire procedure of registering as a corporation. Aside from this, the cost to form a corporation is much higher than that of an LLC (or any other business structure, for that matter).
The most common types of corporations are:
- Regular corporation
- Statutory close corporation
- Professional corporation
- Non-profit corporation
There’s no general rule when you should register as a corporation. However, since it provides a lot of liability protection, corporations are a great choice for medium- and high-risk businesses. Companies that plan to go public or engage in serious fundraising campaigns should also register as a corporation. Others would probably enjoy the benefits of forming an LLC.
One of the most unique business structures is the cooperative. This is a private business owned by people who use its products/services. The key to forming a cooperative is to group the bargaining power of these individuals to create better leverage. The enterprise’s control is also different from in other business structures because each member has the control equal to their percentage of their holding in the company.
There are also several downsides of the cooperative business structure, some of which may help flesh out the benefits of being an LLC. First of all, a cooperative lacks centralized power. Second, there’s not much incentive when it comes to attracting large capital. Third, unlike LLCs, the majority of cooperatives don’t have a professional manager. This is mostly because hiring one costs money that you would have to pool from all the owners (either equally or according to their equity). In other words, running a cooperative can be a proper logistical nightmare.
Comparison of Business Entities in the US
In general, there are many operational, liability, and tax-based differences between different types of business entities. A table may help you with a more accurate comparison of the pros and cons of an LLC. Three key logistical differences lie in liability protection, treatment, and type of entity (in the eyes of the law and the IRS).
|Business structure||Liability protection||Tax treatment||Type of entity|
|Limited partnership||Yes (only for limited partners)||Personal||Incorporated|
|C-corporation||Yes||Double taxation on dividends||Incorporated|
|LLC||Yes||Can be taxed as a partnership, sole proprietorship, S-corporation, or C-corporation.||Incorporated (unless it is a single-member LLC)|
The key in making this decision lies in finding a solution that provides you with the highest level of liability protection while still allowing you to avoid double taxation. One of the most significant limited liability company advantages is that while this is something you can get from S-corporation and limited partnership, the LLC structure allows you to do so with less red tape.
Benefits of an LLC
Now that you’re familiar with all the different types of business structures available, we can start listing all the reasons for registering as an LLC. Well, there are actually quite a few of them, and here’s a brief rundown.
What are the tax benefits of an LLC?
Some of the biggest benefits of having an LLC can be seen through its taxation. Namely, an LLC can be set up as an S-corporation, which means that you can avoid paying corporate taxes on the income. Instead, the LLC members split the income and pay the respective tax on their personal tax returns. This allows you to have the liability protection of a corporation but still avoid double taxation. In other words, each member will pay taxes based on their personal profits or losses. This is a prominent LLC tax advantage that shouldn’t be overlooked.
Still, it’s worth mentioning that there are other types of an LLC. For instance, running an LLC as a sole proprietor (single-member LLC), the IRS will treat you no differently than someone running a sole proprietorship.
Another alternative is for you to run an LLC as a C-corporation, in which case you can’t avoid double taxation. The corporation will first pay taxes on a profit (seeing as how it is taxable by an IRS as a legal entity). Then, each member gets to pay income taxes on their personal record, as well. When discussing the pros and cons of an LLC, this is the issue that is probably brought up most often. You should also keep in mind that corporate tax rates vary state by state.
To sum it up, the main advantage of paying a tax as an LLC is the flexibility.
How do you benefit from limited personal liability?
Another massive advantage of running an LLC is the limited personal liability. This, however, can only be achieved through specific conditions. As a member of an LLC, your personal assets are protected, and there’s liability only for the assets you’ve invested in the company. This is, beyond doubt, one of the biggest benefits of creating an LLC.
In other words, if things go south, you only risk losing your equity in the LLC. In this scenario, your home, personal bank accounts, vehicles you own, and family heirloom are safe from repercussions.
Keep in mind, though, that this limited liability protection doesn’t absolve you of any liability whatsoever. For example, as an acting manager of an LLC, you still have legal responsibility for the actions of the company. Also, as a manager of a multi-member LLC, you may be responsible for the funds of other members.
Lower costs and fewer administrative responsibilities
When weighing the pros and cons of LLCs, the key thing to point out is its simplicity and flexibility. Sure, registering as a sole proprietorship is the simplest way for an entrepreneur to become a legal entity, rather than being seen as a natural person (which is the case with sole proprietorship). Those looking for a cheap and straightforward way to register as a business can always go for a sole proprietorship structure. Yet, this type of entity comes with certain limitations.
In other words, an LLC is a perfect compromise between sole proprietorship and corporation. The advantages of a limited liability company lie in the fact that you get the liability protection of a corporation without having to pay as much or handle as much administrative work.
In different business structures, profits are shared in a predetermined manner.
- For instance, it’s common for profit to be shared equally among partners in a general partnership.
- A sole proprietor has nothing to share as there’s no difference between them as a natural person and their enterprise as an unincorporated entity.
- In a corporation, shareholders are paid dividends according to their equity in the company.
One of the biggest advantages of forming an LLC is that you can specify the profit-sharing model in the operating agreement. One’s equity in the company doesn’t have to match their investment of time and effort into that LLC. So it’s only fair for the owners to be able to settle this among themselves. Also, keep in mind that this has to be specified during the LLC foundation.
No restriction in the number of members
Previously, we’ve mentioned that the IRS doesn’t recognize a difference between a single-member LLC or a sole proprietorship. But what if your LLC has more than one member? One of the benefits of forming an LLC is that there’s no maximum number of members. While this may sound a bit absurd as an advantage, keep in mind that entities like S-corporation are capped at 100 shareholders.
What Is the Downside to an LLC?
There are several disadvantages of an LLC worth mentioning. First, it costs more to start than a sole proprietorship. It’s also more expensive in the long run, as sole proprietorships don’t have to pay annual fees. Moreover, an LLC has a limited life, which means that you have to renew your registration on a regular (annual in most states) basis.
When discussing the pros and cons of LLCs, it’s also important to mention the issue of potential ownership transfer. You see, ownership transfer is also more complex than it would be with a corporation. But, on the other hand, with sole proprietorship, ownership transfer would be impossible since the proprietor and proprietorship are one and the same.
A limited liability company provides business owners with an inexpensive and flexible way of registering as a legal entity.
To sum it up, the benefits of an LLC are limited liability protection, taxation flexibility, and the ability to decide how to share profits. The level of control and customization of your business is similar to that of a sole proprietorship, while the level of liability protection is similar to that of a corporation. That being said, the LLC structure allows you to get the best of both worlds.