Advantages and Disadvantages of Forming an LLC

Advantages and disadvantages to forming an LLC

If you’re looking to form an LLC, you should know that there are plenty of points to be made both for and against the limited liability company as a business structure, depending on your priorities. In this article, we’ll discuss some of the pros and cons of forming an LLC to help you decide whether or not it’s the right business structure for you.

Advantages of Forming an LLC

1) Personal Asset Protection

The primary benefit of forming an LLC is right there in the name: it limits your personal liability, or in other words, protects your personal assets. This means that lawsuits against your company cannot target assets that you own as an individual.

As long as you follow the rules and regulations involved with operating an LLC, creditors cannot go after your personal real-estate holdings, the money in your personal bank account, or any of your other personal assets. For many entrepreneurs, this alone is enough to tip the scales in favor of an LLC.

 

2) Easy to Form

The process of forming an LLC basically boils down to paying a nominal fee and providing the state of formation with some details about your business. This is much simpler than the notoriously difficult task of forming a corporation.

Each state has its own rules and regulations, but for the most part you’ll just need to file Articles of Organization (a document that lets the state know where your business is located, when the LLC is to be officially formed, etc.) and nominate a registered agent (a person or company that receives important legal documents on behalf of your LLC). Depending on the nature of your business, there may be several other steps involved, but in most cases it’s a pretty straightforward process.

 

3) Simple Maintenance

Maintaining an LLC is also much easier than maintaining a corporation. Most LLCs just need to file an annual report, and maybe acquire a couple business licenses to remain compliant.

On the other hand, corporations must hold regular board meetings, shareholder meetings, and fulfill tons of other corporate formalities. All in all, corporations simply involve far more work when it comes to ongoing maintenance.

 

4) Favorable Taxation Model

Limited liability companies use what’s referred to as pass-through taxation. This means that instead of filing a corporate tax return, the company’s revenue is passed through to the LLC’s owner(s). Whereas corporations often face double taxation (the corporation and the shareholders must pay taxes on the profits), LLC owners simply claim the business’ profits and losses on their personal tax returns.

 

5) Enhance Client Perception

Let’s say you’re looking for an electrician to come check out some faulty wiring. Who would you rather call: John Doe, or Doe Electric LLC? Which one of these sounds more professional?

By forming an LLC, you can legally operate your business under a name besides your own personal name, allowing you to enhance customer perception.

 

6) Structural Adaptability

As opposed to corporations, which are pretty rigidly structured, LLCs have some flexibility when it comes to operating procedures. For example, you’ll be able to decide how the business is taxed, whether it will be managed by members or managers, and exactly how you want to split up the profits.

 

7) Great Option for Foreign Businesses

There’s no citizenship requirement when it comes to forming an LLC. You don’t have to be from the U.S., you don’t have to be a resident — you can even operate an LLC in any state you choose without ever setting foot in America.

 

8) Keeping Business Income Separate

In addition to the financial benefits we’ve already discussed (personal asset protection and pass-through taxation), LLCs also make it much easier to separate your personal and professional income than sole proprietorships do. Because LLC ownership allows you to open a business bank account and acquire business credit cards, it’s easy to keep your finances separate and organized.

Disadvantages of Forming an LLC

All that said, it’s not entirely good news when it comes to forming an LLC. Although the advantages do outweigh the disadvantages in most cases, there are still some negatives that are worth pointing out.

 

1) Fewer Options to Raise Funds

In a corporation, you can issue stock in exchange for funding, which is a serious advantage over an LLC. Because LLCs cannot issue stock, there are fewer potential sources of funding to fall back on if you start running low on money. Simply put, if you form an LLC, you will not be able to sell shares of your company.

 

2) Maintaining the Corporate Veil

In order to maintain the limited liability protection afforded by an LLC, you must maintain the corporate veil. Otherwise, if your LLC is sued, your personal assets could become available to creditors.

The most common ways your corporate veil may be pierced are 1) if a court rules that the LLC is not a totally separate entity from you as an individual, or 2) if you are found to have committed reckless acts as an LLC owner. In these instances, creditors could go after your personal assets.

 

3) Different Rules in Different States

LLCs do not have a uniform structure across the U.S. Each state has its own rules and regulations, which can become an issue if your company operates in multiple states. In this case, you’ll have to fulfill various compliance requirements for each state you’re operating in. Corporations and other business structures do not pose this problem.

 

4) Self-Employment Taxes

While avoiding the corporate double-taxation model is absolutely a plus for LLCs, some LLC owners are subject to paying self-employment taxes. In other words, the IRS charges them additional taxes to cover what would be the employer’s share of that person’s social security and Medicare contribution. If you are considered self-employed via your LLC, you will be subject to a 15.3% self-employment tax.

In Summary

Limited liability companies are the most popular business structure for a reason, and although they pose a few potential issues, in most cases the pros outweigh the cons.

That said, we encourage you to weigh the advantages and disadvantages we’ve discussed throughout this guide before deciding whether or not an LLC is the right fit for your company.

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