If you’re self-employed, it’s common to structure your business as an LLC. However, it’s not necessary for every entrepreneur. According to the IRS, LLCs represented just 10% of non-farm sole proprietorships in 2020.
So, how do you decide if an LLC is right for you?
What is an LLC?
LLC stands for Limited Liability Company. It’s a state-regulated business structure that offers the pass-through taxation of a partnership or sole proprietorship and the limited liability protection of a corporation. With this setup, owners avoid both corporate taxes and the liability pitfalls that plague operations with less formal structures.
LLCs can be single or multi-member operations. Either way, the LLC itself is not taxed. Instead, profits pass through to the individual members’ tax returns.
LLC Advantages
Here are some potential benefits of forming an LLC:
- Pass-through Taxation: Corporate owners face double taxation, once at the corporate level and again at the individual level. Because LLCs can distribute profits directly to owners’ tax returns, they’re only taxed once—individually.
- Limited Liability Protection: As we mentioned, incorporating as an LLC helps shield your personal assets if the business is sued or has debts.
- Credibility: Clients and investors may take your business more seriously if it’s a formalized LLC.
LLC Disadvantages
LLCs come with some potential downsides as well:
- Startup Costs: Forming an LLC isn’t free. Costs vary by state and may include both an initial fee and an annual one.
- Potential for Personal Liability: LLCs offer limited liability protection. You can still be held personally liable for actions such as fraud or negligence.
- Self-Employment Tax: Multi-member LLCs must pay self-employment taxes on their share of the profits, even if the money remains in the business.
Who Should Form an LLC?
Any sole proprietorship or general partnership can form an LLC. However, the move makes the most sense for businesses exposed to extra risk, whether through partners, employees, or the nature of the business.
Let’s look at these factors in more detail.
Partners
If you’re going into business with one or more partners, forming an LLC is a good strategy. The LLC is a buffer between your personal assets and any potential liabilities from your partner’s actions.
Employees
If your LLC has employees, the protection of an LLC can be beneficial. Employees may also feel more secure working for an LLC.
High-risk Industry
The realities of your industry might expose you to more risk than other businesses. For example, a contractor working in other people’s homes would benefit from the limited liability protection of an LLC should anything go wrong.
Who Should Not Form an LLC?
Simple businesses that are less likely to face legal action may not need the extra expense and paperwork required to form an LLC. For example, if you run a small, home-based business offering services like freelance writing or graphic design, it may be easier and more cost-effective to operate as a sole proprietorship.
Make the Right Choice for Your Business
Deciding whether to form an LLC is a significant decision. Consider the benefits and drawbacks outlined in this guide, as well as your long-term plans. A financial professional can help you make a decision based on your unique circumstances.
At Kondler & Associates, CPAs, we’re dedicated to supporting small business owners. Our expert team can provide personalized guidance on business formation, tax planning, and financial management.
Contact us today to learn how we can help with forming and operating an LLC.
