Settling on a particular type of business formation carries with it long-reaching business repercussions. The types of taxes to be remitted, the extent of your personal liability and the type of business regulations affecting the entity depend on the type of your business. A commonly chosen business structure is a Limited Liability Company (LLC).
A limited liability company is a flexible type of business enterprise, incorporated and operating within a certain jurisdiction. It blends various aspects and structures of a partnership and a corporation. It is a legal entity, recognized by a majority of United States jurisdictions, which provides limited liability to its owners.
Although distinct in its own sense, a limited liability company shares numerous similar characteristics with an S-Corp or C-Corp but has more flexibility. There’s also less paperwork involved. LLCs have more advantages compared to other types of businesses like Sole-Proprietorships, Partnerships, and Corporations.
Types of Limited Liability Companies With the Benefits and Disadvantages
Generally, according to the Inland Revenue Service, a limited liability company is not considered a separate entity when it comes to tax requirements. In this case, the IRS does not tax the LLC directly and instead allows its members to determine how they would want to be taxed.
There are three main types, each with its own distinct characteristics, advantages and disadvantages. These include Single Member LLCs, Partners in an LLC and LLC filing as a corporation. Here are the characteristics in relation to each type of LLC.
Single Member LLC
Single Member LLC are taxed as a sole proprietorship. Unlike other types, the profits and losses incurred by the business are not taxed directly. Taxes are remitted through the single owner’s individual federal tax returns. This comes with many advantages including flexibility of remitting taxes, the convenience of monitoring returns and exclusion from other tax regimes like corporate tax. The main disadvantage of this type is the inability to benefit from tax benefits that other types of businesses like corporations enjoy. For example, insurance and travel.
Partners in an LLC are taxed not as an entity but rather individually on each member partner. Just like a sole-proprietorship, Partner LLCs are exempted from federal taxes. Each partner remits taxes from the income gained from the partnership. Similarly, taxation on this type of LLC guarantees flexibility and convenience of tax payment as well as exemption from other tax regimes liable to other types of companies.
LLC filing as a Corporation files returns by abiding by normal corporate tax rules. The company is supposed to apply for, and file Form 1120, U.S. Corporation Income Tax Return. The members of the company have the liberty to choose whether to file as a corporation or as a normal limited liability company. The earlier comes with numerous benefits enjoyed by corporations when filing returns. They include federal tax exemptions on profits and distributions and tax-free benefits like insurance and travel.
Benefits of LLCs
All types of limited liability companies are separate legal entities and operate as so. The business hence protects the owners through limitation of the owner’s personal liability. Any debts owed by the business and claims against it by her creditors are limited to the extent of the assets the business owns. When settling debts and claims, the personal assets and property of the owner(s) cannot be pursued to settle the claims.
Single Member LLCs, Partners in an LLC and LLC Corporations operate as separate legal entities and hence guarantee limited liability to the owners or members.
The corporate veil, however, does not extend to illegal acts committed by the owners. The principle of limited liability only extends to legal actions performed by the owner. It can hence be disregarded in cases where the owners are liable for illegality or negligence.
The formation and running of any type of LLC is relatively more flexible and convenient compared to other types, e.g., corporations. Normally, a limited liability company requires little paperwork to incorporate. There are very few federal laws and requirements associated with registering a limited liability company. Corporations, on the other hand, are subjected to stringent state and federal regulations to register and run. Corporations are, for example, required to hold annual meetings between management and shareholders and file reports with the government. Limited liability companies are not required to do so except, to some extent, for an LLC treated as a corporation.
Disadvantages of LLCs
Except where an open agreement is signed, a limited liability company ceases to exist upon the withdrawal of the owner in all types of LLCs. Unlike corporations that are not affected by the demise of a member, LLCs have to expressly agree on the effect of a member’s withdrawal on the company.
Unlike corporations, limited liability companies do not provide clear roles for the members. In a single LLC, for example, the owner assumes all tasks of management and running of the company. This can, however, be solved by adopting an operating agreement during the incorporation process.
All limited liability companies are subject to self-employment tax except for LLCs operating as corporations. Profits are not taxed at a corporate level but rather on each member’s personal federal tax remittances. It is usually higher compared to paying at a corporate level.
Important Facts About LLCs
A limited liability company guarantees both flexibility and protection. This is because it affords the owner protection against claims while requiring little paperwork to incorporate and run. It is also convenient to monitor compared to other types of businesses such as corporations. Nevertheless, LLCs do not enjoy the benefits of corporations like tax benefits and exemptions except for LLCs operating as corporations. Here are the important facts to consider when you’re debating if an LLC is right for you:
A limited liability company is a distinct legal entity and operates like one.
There are different types of LLCs including, Single Member LLCs, Partners in an LLC and LLC Corporations.
All three types have similar characteristics except when it comes to filing returns and ownership structure.
Limited liability companies provide limited liability over the owners' assets, but only to the legal activities they undertake.
Except for limited liability companies operating as corporations, all the other types are subject to self-employment taxes by the government.