LLC Pros & Cons for Small Businesses
So you're ready to start a small business? There are many steps ahead, but now that your business idea and plan is ready, it's time to think about the pros and cons of an LLC versus a corporation. An LLC is popular with small business owners for liability protection, management flexibility, and tax advantages.
In this article, we’ll break down the advantages and disadvantages of an LLC and outline the process of creating an LLC for your small business.
What Is an LLC?
LLC stands for limited liability company. LLCs are business structures that offer limited liability protection and pass-through taxation. Just like corporations, the LLC legally exists as a separate entity from its owners, meaning the owners cannot be held personally responsible for the business debts and liabilities.
Owners of an LLC are called members and each member must file a tax return for the LLC. Additionally, they must report the income or loss on their personal tax returns and pay any necessary taxes.
Pros of an LLC
- Personal assets are protected. LLC members are generally not personally liable for debts incurred by the LLC, and their personal assets are protected in business-related lawsuits.
- Pass-through taxation. LLC owners have a pass-through deduction under the Tax Cuts and Jobs Acts which runs through 2025. This act allows the business's profits or losses to pass through to the owner's personal tax return under the owner's personal tax rate.
- Easy to create. Your state’s Secretary of State website should have all the information you need to create an LLC. Depending on where you live, the fee could range from less than $50 to a few hundred dollars. Typically, this process can be done online in a few hours.
- Profit distribution. If your LLC is doing well enough to make a profit you can take a “draw” instead of a salary. This is especially appealing because the draws are not taxed, but you do report your share of the profits on your personal tax return.
Cons of an LLC
Now that you understand some of the pros of an LLC, there are a few potential drawbacks to consider before committing to an LLC.
- Set up expenses. An LLC usually costs more to form and maintain than a sole proprietorship or general partnership. States charge an initial formation fee, and many states impose ongoing fees, such as annual reports and/or franchise tax fees. Regulations and fees vary state by state, so be sure you’re up-to-date with your state’s rules.
- Transferring ownership. If you think you might want to transfer ownership of your LLC, there are a few extra hurdles to consider since all members typically have to approve ownership changes.
How to Form an LLC
Remember, each state has its own unique LLC formation requirements, so there is no one size fits all guideline for forming an LLC. But, in general, there are six steps everyone must follow.
- Name your LLC
- Appoint a registered agent
- File articles of organization
- Get an Employer Identification Number (EIN), also known as a Federal Tax Identification Number
- Prepare an operating agreement
- Open a business checking account
Once those steps are completed, your LLC is formed. Congrats!
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Optimum does not offer tax advice. Business owners should check with an accountant for any tax related questions.