When you’re setting up or changing the structure of your business, there is a lot to think about.
Do I Need An LLC? What Are The Options?
There are many forms of business structure to chose from, such as:
- Sole Proprietorships & General Partnerships
- Limited Liability Companies (LLCs)
- S-Corporations
- LLC with S-Corp Tax Election
- C-Corporations
In our first installment we looked at sole proprietorships and general partnerships. Today we’ll consider limited liability companies.
Limited Liability Companies
At Leigh Law we are big believers in giving folks the same advice that we use ourselves, and we are big fans of the limited liability business concept. Limited Liability Companies are relatively new forms of business structure that combine the best of both worlds of corporations and partnerships.
According to the IRS, an LLC is “designed to provide the limited liability feature of a corporation and the tax efficiencies and operational flexibility of a partnership.” This combination allows members to participate in the management and operation of the business, with the asset-shielding features of corporations.
Ownership Of An LLC
An LLC may have an unlimited number of members, and also allows for special allocation of the profits of the business pro-rata to the members’ ownership. In other words, the larger your ownership share, the larger your share of profits.
Membership in an LLC is not limited to individuals; corporations can be members as well. The contribution of a member can be a capital investment, the donation of vehicles, tools, materials, real estate or other assets to the LLC. A member may alsw loan funds to the LLC and have the loan repayed with interest, ownership shares or a guaranteed payment (subject to the assets of the LLC). Sweat equity is also a valuable contribution.
Allocation Of Ownership And Profits
It’s up to members to decide how to allocate shares among themselves, considering the contributions of each member.
There are very few restrictions on how profits are shared among members. Typically, the profits might be shared in proportion to the percentage of ownership of each member.
Protection Against The Liabilities Of The Company.
Members enjoy limited liability as well, which means that members are not personally responsible for the debts and liabilities of the company. If everything goes wrong, a member may lose what they invested in the business, but no more. There are some exceptions* but this is one of the biggest benefits of an LLC.
(* The limitation does not necessarily apply to employee tort actions, including accidents.)
Compare that to a sole proprietorships or general partnership. The sole proprietor is liable for everything, and partners are liable for business debts even if they were incurred by another partner without approval!
How Are Taxes Handled?
By default, an LLC is a “pass-through” entity for tax purposes. In other words, the profits or losses of the business pass through directly to each member/owner’s personal tax return, just as they would in a sole proprietorship or a partnership. Since the member’s share of profits is reported as income on that member’s Form 1040, it is subject to self-employment tax.
The IRS allows an LLC to choose to be taxed as an s-corporation, providing the same corporate tax benefits for an LLC. However, each member’s pro rata share of profits is taxable income, whether or not it is distributed to that member in that taxable year. LLC taxation is also allowed as a sole proprietorship, partnership, or C corporation too. The pass-through taxation is not double taxation like a corporation but could deter investors in an LLC-structured start-up business.
LLCs are effective estate planning tools for business partners, if designed correctly, avoiding probate when members die.
Less Paperwork, Less Organizational Overhead
An LLC is governed by its operating agreement and is not saddled with detailed corporate minute and meeting requirements to maintain its status as a limited liability company. LLCs are considered “corporations” and are required to file Articles of Incorporation with the Secretary of State’s office, but are allowed extreme flexibility by members to tailor the day-to-day structure through an Operating Agreement. LLCs also enjoy no annual meeting requirement and are not forced to establish and maintain a Board of Directors. The paperwork and recordkeeping is much reduced when operating as an LLC.
If the LLC has more than one member, the operating agreement is critical. It needs to address day to day operations, how money and capital goes in and how money and capital comes out, who handles the books, the taxation style, and what happens when a member dies. It should also address the eventual dissolution of the LLC.
Startup Costs
Some states, including Arkansas, charge an additional franchise tax. This is minimal cost of $150 annually. The lack of clear corporate structure requires a detailed operating agreement, which can also increase start up costs, including attorney’s fees. Overall the start up costs for an LLC versus any other business entity (save for sole proprietorships) is much less.
Are you a “do it yourself-er?” It is totally possible to create your own LLC directly through the Secretary of State and handle your own taxes, particularly if you are a single member LLC. The benefit of involving legal and tax counsel on the front end is to answer your questions, make sure you understand the process, and to draft your operating agreement to address all possible scenarios with your co-members.
Talk To Your Lawyer & Accountant
Consult with your lawyer and your accountant. They have worked with many business owners and have a good idea of what can happen and how to forestall the worst consequences. An ounce of prevention is worth a pound of cure, as the saying goes, and it couldn’t be more true than in this context!
In addition to formation, dissolution, and the daily operations of the business, the tax implications need to be carefully considered. Self-employment tax is high and if you are making or think you might make more than a specific annual cut-off, you will be responsible for estimated quarterly taxes, unemployment tax, excise tax (depending on your goods or services).
Leigh Law Can Help
Give us a call at Leigh Law to help you figure out the options and what the likely realistic result is in your circumstances! We’d love to Roar to your Rescue!
Call For A Free Case Evaluation
Case evaluations are completely free; our fees are flat and affordable. Call Leigh Law today at (501) 227-ROAR or Email Us to set up a free consultation.