Let’s take a look at the Limited Liability Company or LLC for our next choice of business entity. Each State has setup its own version of a Limited Liability Company statute. This means that a State will grant you the opportunity to operate as an LLC which is a separate legal entity, different than yourself. You agree to identify as and hold your company out to the public as an LLC and in return the State will give you as the owner limited personal liability protection. Sole Proprietors have unlimited liability for their business. An LLC entity limits that liability to the assets of the company and builds a wall, or a “veil” as it is sometimes called, which prevents a creditor from going after your personal assets thereby limiting the personal liability of the owner. (Of course many creditors require you to personally guarantee a loan which allows them to go after your personal assets.) The limited liability also helps for other types of liability protection too.
There are three types of LLCs. The owners of an LLC are called members. The first type is a single member LLC. This is an LLC with only one member. It is a separate legal entity as granted by the State but for tax purposes it is a “disregarded entity” which basically means it will be treated as a sole proprietorship for tax purposes. A single member LLC is then essentially a sole proprietorship with limited liability protection.
The second type of LLC is a multi-member LLC. This is an LLC with two or more members. It is a separate legal entity as granted by the State but for tax purposes is treated as a partnership. (We will talk about partnerships later.) Each member has limited liability.
The third type of LLC is a Benefit LLC or BLLC. Not all States offer this form of LLC. It can be a single member or multi-member LLC but it has an additional responsibility to report to the public its social responsibility or company citizenship. The State will grant the separate legal entity and recognize that the purpose of this LLC is to focus on people and the planet in addition to profit. Their business purpose includes consideration of non-financial stakeholders as well as the financial interests of the members. The state grants legal protection for “doing good” even if it costs the members money. There is no tax advantage for registering a BLLC. It is treated as a single member or multi-member LLC for tax purposes. If your business mission includes being socially responsible and improving the planet and the people who inhabit it in addition to making a profit, you may want to consider it. It requires you to annually report to the public on your activities and social good as it pertains to your mission. The BLLC entity allows the public to know that your business mission goes beyond profit motivations.
The primary benefit of an LLC is the limited personal liability it provides. They are relatively easy to setup and have less paperwork than corporations do. LLCs do not pay taxes. Profits are reported on the owners’ personal returns and the owners are responsible for the income taxes (pass-through taxation). They also have flexible ownership rules, management structure and profit distributions. They are the most common form of business entity after sole proprietorships. As a separate legal entity, it can be sold or transferred.
Some of the disadvantages include dissolution of the entity for tax purposes if members leave the LLC, and profits are still subject to self-employment taxes if the member participated in the business. There are some administrative requirements that exist that sole proprietors do not have to follow. There are also additional registration costs and possible additional tax preparation fees if a separate return is required. If the LLC is slow to file its tax return, the members have to wait to file their individual returns too.
To register a LLC, articles of organization must be filed with the State and fees paid. These articles include the name, address, business purpose and duration of operation. If there is more than one member or you intend to add members in the future, it is very wise to also create an operating agreement for the LLC. An operating agreement outlines what you will do in certain situations such as a member leaving or a new member coming in. Having an operating agreement eliminates a lot of conflict and provides answers to questions when certain events occur.
You may want to consult your attorney in setting up an LLC and drafting an operating agreement.
I operated my side business as a sole proprietor for many years. Once I made it my full-time business, I setup a single-member LLC to get the greater benefits an LLC provides
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