Advantages of an LLC
Limited liability companies are popular for a reason. LLCs have better internal protection from liability than corporations. They also offer more tax structure and profit-sharing options than a sole proprietorship or general partnership. This combination, plus easy formation and flexible management, makes LLCs the go-to structure for small businesses.
In this article, we'll cover the main advantages of starting an LLC:
- Strong Liability Protection
- Flexible Structure
- Reduced Paperwork
- Control Over Profit Distribution
- More Tax Options
- Additional LLC Advantages
Strong Liability Protection
LLCs are great at protecting members from liability. LLCs are legally separate entities from their owners, which helps insulate members from company liabilities.
In a sole proprietorship or general partnership, there’s no separating a company from its owners, making it very difficult to protect your personal assets from being seized to satisfy business debt or judgments. Owners risk losing their savings, vehicles, real estate and more. If the same happens to your LLC, the liability stays with the company. While you might lose money you’ve invested in the LLC, your personal assets remain safe.
More than any other business type, LLCs offer flexibility. Your LLC can be structured for single-member or multi-member ownership. You also have the option of running the show directly as a member-managed LLC, or appointing administrators to handle your company’s everyday business as a manager-manged LLC. A corporation, on the other hand, requires you to follow a much stricter management structure.
Single-member LLCs are as independent as sole proprietors: free to make business decisions without partners or a board’s input. Unlike a sole proprietorship, LLCs also have liability protection from business debts or judgments.
Multi-member LLCs (LLCs owned by more than one person) are also free from the organizational structure of a corporation. You can run the LLC yourselves or choose managers to do so, without the strict hierarchy corporations need. And with no duty to shareholders, you and your partners can choose how to run your business beyond solely prioritizing profits.
Protections Against Personal Liability
Corporations shield shareholders from liability too, but most LLCs can also do it backwards—protecting the company from members’ personal liability. Corporations are vulnerable to this—stocks are personal property and can be seized by creditors, who also get the equivalent amount of ownership in the corporation. If a majority portion of a corporation’s shares are claimed this way, the creditor can take control of the company, and may choose to sell assets or liquidate the business to pay those debts.
LLCs are harder to lose control over. LLC member debts are handled by charging orders, which are similar to garnishments. In a charging order, a court places an LLC member’s financial distributions under a lien, forcing the LLC to instead pay those distributions to a creditor until the debt is paid. In these cases, the creditor can only be paid distributions—they do not become an owner member of the LLC or gain any management rights over it. Some states do allow creditors to foreclose on a member’s financial interest, taking it over permanently—or, they can sell their interest to another party. But even under foreclosure, the person receiving the interest still has no say in running the company.
In most states, charging orders are the only way a creditor can attempt collect a member’s personal debt from an LLC. There are only a few exceptions—New York is a notable one—that allow creditors to use stronger methods, like obtaining a court order to force the sale of the LLC’s assets, which may lead to the dissolution of the company if those sales can’t cover the debt.
Are single-member LLCs protected from charging orders?
Single-member LLCs have no other members to protect from personal debts or judgments, and are also more likely to be found to be an alter ego—insufficiently separated from the sole member. This means single-member LLCs can be more vulnerable to charging orders.
LLCs are usually much easier to form than a corporation, and need to jump through fewer administrative hoops to maintain good standing in a state. Articles of Organization generally require less information than comparable documents for a corporation. LLCs also have less strict requirements for regular meetings than corporations do.
LLCs are formed by filing Articles of Organization with a state. Specifics vary, but usually only basic information is required:
- The LLC’s name.
- The names and addresses of members, managers and a registered agent.
- Whether the LLC will be member-managed or manager-managed.
In Delaware, Nevada, New Mexico and Wyoming, you can even skip names and addresses of members and managers with an anonymous LLC.
In contrast, filing a corporation’s Articles of Incorporation usually requires that information and then some, including a physical address, names and addresses of initial directors, information on how the corporation will operate and its purpose, plus specifics about the amount of authorized shares, their classes and value.
Which is cheaper to create, an LLC or corporation?
It’s a narrow margin, but LLC formation fees are lower in slightly more states than those with cheaper incorporation fees. A little under half of all states charge the same formation fees for either entity.
Reports and Meetings
With a few exceptions, all LLCs and corporations must file reports with the state—usually annually, but sometimes biennially, or in Pennsylvania’s case, every 10 years. Arizona, Missouri, New Mexico and Ohio do not require LLCs to file reports, and in South Carolina, only LLCs with S-corporation status must do so.
When it comes to mandatory meetings, however, your LLC has more freedom than a corporation. Corporations must hold at least two annual meetings—one for directors, one for shareholders—and must record meeting minutes for record-keeping purposes. An LLC may choose to hold regular member meetings, but aren’t required to do so. LLC record-keeping is also held to much looser standards.
Do LLCs have lower report fees than corporations?
Overall, LLCs have it slightly easier than corporations in regard to annual or biennial reports. Several states charge lower fees for LLC reports, and in a few states, LLCs are not required to file reports at all. Fees that vary based on stock can also make corporation report bills much higher than those for LLCs in some cases.
Only a small number of states charge LLCs higher fees on annual reports, but they tend to be significantly more expensive: Massachusetts, North Carolina and Tennessee all have LLC fees that are hundreds of dollars higher than those for corporations.
California charges a whopping $800 franchise tax for both corporations and LLCs, but LLCs making more than $249,999 on income from California are also required to pay an additional annual fee—$900 at the low end and $11,790 at the very top. New businesses can waive the $800 franchise tax in their first year until 2024.
Control Over Profit Distribution
Most types of businesses come with rules on profit distribution—partnerships get equal shares, and corporate shareholders get distributions based on their amount (and type) of share. By default, an LLC distributes profits based on percentage of ownership interest. However, your LLC can have different standards for profit allocation, if you choose to outline them in an operating agreement.
For example, members can agree to give another member a larger share of profits for doing regular work on the LLC’s behalf. Alternatively, if a member contributed more money to the LLC’s capital, the other members may agree to pay that contributor more until the additional money is repaid.
Bear in mind, however, that an LLC may not be able to give distributions if the company’s current debts and other liabilities are higher than its assets. The Internal Revenue Service may also give any non-standard allocations a closer inspection come tax time, to ensure income isn’t being manipulated to lower the tax burden of LLC members.
More Tax Options
LLCs aren’t a federal tax classification, but that doesn’t mean you shouldn’t think about how your LLC will be taxed. Depending on how many members an LLC has, the IRS classifies it as either a sole proprietorship or partnership by default. However, your LLC can elect to be classified as a C- or S-corporation instead, if you prefer. Each of these options are beneficial, depending on your tax goals.
Classified as a partnership or sole proprietor, your LLC benefits from “pass-through” taxation. This means profits are only taxed once, passing through the company to members’ individual income tax return. Members are considered self-employed under this classification and must pay self-employment taxes for Social Security and Medicare. Meanwhile, corporate profits get taxed both as business income and in shareholder income taxes on dividends—a principle sometimes called “double taxation.”
By electing to be classified by the IRS as a C-corporation, your LLC gets directly taxed at the normal flat corporate rate, which may be lower than personal income tax rates if your company is profitable. Members become shareholders and only pay personal income tax on dividends. You will still pay corporate taxes , unfortunately, but on the upside, you won’t be on the hook for self-employment taxes.
US-based LLCs that meet certain requirements may instead elect for S-corporation classification, which can help members save on taxes. These companies can use profits towards payroll for employees (including members providing services to the business), then pay the remaining profit to members as personal income with a distribution that isn’t subject to self-employment taxes. This approach works best if your LLC already earns enough income to cover the cost of payroll, so it may not be ideal for a business just starting out.
Is it true LLC owners can save an extra 20% on taxes?
It depends on your LLC’s tax classification. Under the Tax Cuts and Jobs Act of 2018, owners of pass-through businesses (like sole proprietorships, general partnerships, default LLCs and S-corporations) filing personal income tax may qualify for a Qualified Business Income deduction of up to 20%. QBI deductions exclude capital gains, interest and dividends.
Income restrictions apply, and high earners in personal service businesses—including doctors, lawyers, performers and brokers, just as a few examples—may not be eligible. Members of an LLC which has elected for C-corporation classification are also ineligible.
Additional LLC Advantages
There are a couple of other benefits that apply to LLC businesses, in addition to the many advantages previously listed. For one thing, LLC status provides a sense of credibility to customers that may be missing from less formal business structures. And in many states, the combination of an LLC and a professional registered agent service allows for more privacy from the public record than most types of corporations are capable of.
Don’t count out an intangible benefit: LLCs being perceived as a more serious business than a sole proprietorship or partnership. An “LLC” at the end of your business name conveys a sense of respectability and professionalism to customers and investors that other, less formal company names may lack. In a business environment where companies need every advantage they can get, the legitimacy bestowed by LLC status may be the last boost needed to boost the scales from a less structured competitor to your company.
When forming a business with your state, the information filed in your articles of incorporation or organization become public record, and can be easily found by others—including spammers, hackers, nuisance suit filers, and more. As mentioned, four states allow fully anonymous LLCs that obscure all ownership records, but most states require LLCs to provide at least an address and the name of a person authorized to represent the company. This represents a real risk to your privacy.
However, all LLCs must name a registered agent, and they can file formation paperwork on your LLC’s behalf. If you are your own agent (or a family member, employee or friend is), that doesn’t make it too hard for others to trace your identity as an owner of the LLC. But if you hire a professional registered agent service—Northwest, for instance—that agent can use their office address as the official address of record for your company, and in many parts of the paperwork, use their name in place of your own. This makes it much harder for curious people to poke their noses into your business.
Several states clearly exclude single-member LLCs from charging order protections, and many others make no distinction between types of LLCs in their charging order statutes—leaving the exact protections granted to single-member LLCs somewhat ambiguous. However, single-member LLCs are specifically protected under charging order statutes in five states: Alaska, Delaware, Nevada, South Dakota and Wyoming.