Many small businesses are organized as limited liability companies, or LLCs, because an LLC offers many of the same liability protections as a corporation, but with a less rigid structure and fewer administrative requirements.
But not everyone needs an LLC. Some businesses will do just fine as sole proprietorships, while others should form a corporation instead. Here are some basics to help you decide what's right for you.
What will an LLC do for me?
Forming an LLC gives your business its own legal identity. In the eyes of the law, it's a separate “person" that can own money and property, have a bank account, make agreements, sue people, and be sued.
Because of this, your business's creditors generally can't go after any money or assets that aren't owned by the LLC. Your home, bank account, and other personal assets are protected. By contrast, if you operate a sole proprietorship or general partnership, you and the business aren't legally separate, and everything you own is at risk.
LLCs also have other advantages:
- If you have business partners or employees, an LLC protects you from personal liability for your co-owners' or employees' actions.
- An LLC gives you a structure for operating your business, including making decisions, dividing profits and losses, and dealing with new or departing owners.
- An LLC offers taxation options. Most LLCs are taxed as a sole proprietorship or partnership, but LLCs can also choose S corporation or C corporation taxation.
Here's what an LLC can't do
Unlike a corporation, an LLC can't issue stock, and this complicates matters if you want to take on investors. Many investors prefer corporations over LLCs.
If you are a licensed professional such as a doctor, lawyer, accountant, architect, or engineer, your state may not allow you to form an LLC.
Depending on your state, you may choose to form a professional limited liability company, professional corporation, or professional limited liability partnership instead.
There are also limits to an LLC's liability protection. You will still be personally liable if someone sues you for your own negligence or wrongdoing—even if the accusations are related to your business. An LLC does not protect your assets if you personally guarantee a contract or loan. And it won't protect the business itself from losing everything in a fire, flood, lawsuit, or economic downturn.LLC owners may also face the risk of so-called "alter ego" liability, which, under certain circ*mstances, can make them personally liable for their company's debts and obligations. You can help mitigate this risk by making sure to observe the formalities of operating an LLC, such as by holding board meetings, keeping business bank accounts separate from personal accounts, and using separate office space, among other things.
Because of these limitations, an LLC is never really your first line of defense against business problems. Insurance is essential to protect you and your business against the unexpected. An LLC then adds an additional element by helping to protect your personal assets from your business's creditors.
Who benefits the most from an LLC?
Your business is most likely to benefit from being an LLC if either of these is true:
- You have co-owners or employees. Without an LLC or other business entity, your personal assets are at risk if your business is sued for something a co-owner or employee does. An LLC's operating structure also helps to avoid conflict and misunderstandings between you and your business partners.
- Your business has significant risks.Some types of businesses are at high risk for failure. Others have both financial and liability risks. For example, multiple LLCs are a common strategy for rental property owners to ensure that financial problems with one rental don't jeopardize the others—or your own life savings.
Who can skip LLC formation?
Forming a business entity like an LLC or corporation is almost never a bad idea, but it isn't always an absolute necessity for solo business owners.
To decide whether you need an LLC, consider:
- Whether you plan to have partners, employees, or outside investors.
- Whether you have significant contracts or creditors that might lead to financial problems or lawsuits. For example, an unpaid creditor or court judgment could easily cause personal financial trouble if you own commercial real estate, but that's much less likely for most consultants and Etsy sellers.
- Whether you want to have the additional expenses and obligations of forming and running an LLC. There's a fee to form an LLC, and in most states, you must file annual reports and pay an annual fee. You will also need a separate LLC bank account.
If you're trying to limit your business liability, make sure you have adequate business insurance. If you have business partners, employees, or significant risks, an LLC can provide another important layer of protection.
Find out more about Starting a Business
FAQs
The liability protection of an LLC: An LLC can help protect your personal assets from business liabilities. However, if you are not yet generating any income, you may not need the liability protection of an LLC.
What is the disadvantage of an LLC? ›
LLCs offer several benefits over sole proprietorships and partnerships, such as limited liability and tax efficiency, but come with the drawbacks of potential self-employment taxes and complexities in management and ownership transfer.
Should I start an LLC for my side hustle? ›
An LLC Could Provide You with Some Big Tax Benefits
If your side hustle is earning a good amount of money, you might consider forming an LLC but filing taxes as an S Corporation. This lets you reduce your self-employment tax by paying yourself through a combination of a salary and distributions.
Why everyone should have an LLC? ›
Limited liability provides business owners with the protection and peace of mind that they need to commit to growing their business. From personal asset protection and tax advantages to management flexibility and scalability, there are many reasons to consider forming an LLC for your business.
What happens if you start an LLC and do nothing? ›
Simply put, yes, you can have an LLC with no income, but that still has expenses. An LLC with no income but deductible expenses can offset future income through a net operating loss deduction. However, the IRS will still regard this as business activity, so it must be reported yearly.
Can you have an LLC that doesn't make money? ›
LLCs have the flexibility to choose how they want to be taxed. By default, single-member LLCs are considered “disregarded entities,” and multi-member LLCs are treated as partnerships. For a single-member LLC with no income, it's typically simplest to stick with the default disregarded entity status.
Are LLCs bad for taxes? ›
LLCs are considered “pass-through entities,” which means the LLC itself does not pay federal income taxes on business income. Instead, income “passes through” to individual members of the LLC, who pay federal income tax earned from the LLC via their own individual tax returns.
Are LLCs worth it? ›
Without an LLC or other business entity, your personal assets are at risk if your business is sued for something a co-owner or employee does. An LLC's operating structure also helps to avoid conflict and misunderstandings between you and your business partners.
Why is LLC better for small business? ›
LLCs protect you from personal liability in most instances, your personal assets — like your vehicle, house, and savings accounts — won't be at risk in case your LLC faces bankruptcy or lawsuits. Profits and losses can get passed through to your personal income without facing corporate taxes.
Should an LLC owner take a salary? ›
First, you should know that you're not required to take a salary from an LLC. While this may not work for everyone, it's still good to know you have the option. This decision might be best for you if you want to keep the money in the business, or if the company isn't generating enough revenue to pay you.
“There's no hard and fast rule,” says Keren de Zwart, a business attorney who runs Not Your Father's Lawyer out of Irvine, California, “but if your business is netting at least $60K in profits, that's usually a good time to formalize into an LLC or corporation because the tax benefits can really start to be utilized ...
How much money do you have to make to be considered a business? ›
If your small business is not incorporated, you may need to file a tax return and pay the self-employment tax if your net income is $400 or more.
What taxes can you write off with an LLC? ›
LLC tax deductions can help you save money without cutting corners on business spending. Some allowable tax deductions for LLCs include self-employment taxes, legal fees, home offices, and other common and necessary business expenses.
How does an LLC work for dummies? ›
A limited liability company (LLC) is a business structure that offers limited liability protection and pass-through taxation. As with corporations, the LLC legally exists as a separate entity from its owners. Therefore, owners cannot typically be held personally responsible for the LLC's debts and liabilities.
What is the biggest disadvantage of an LLC? ›
1. A major disadvantage of an LLC is that owners may pay more taxes. When setting up as a pass-through to owners, they are subject to self-employment tax. Self-employment tax ends up higher compared to being taxed as an employee.
What if you don't do anything with your LLC? ›
Consequences of Non-Compliance: If you don't file the required tax return or pay the annual fee, the LLC may face penalties and interest on unpaid taxes. Additionally, the state could administratively dissolve your LLC if these obligations remain unfulfilled for an extended period.
Does a single member LLC protect your personal assets? ›
Yes, a single-member LLC will protect your personal assets just as a multi-member LLC will. Forming an LLC is an important step for single-member businesses and will help create the necessary separation between your personal and business assets.
What is the difference between self employed and LLC? ›
There are important differences between LLCs and sole proprietorships. The most significant difference is whether you have limited liability for the business' debts and obligations, as with an LLC, or whether the business' liabilities and obligations fall to you personally in the event of a lawsuit or debt collection.
Is an LLC good or bad? ›
The Bottom Line. LLCs are a good combination of protection with flexibility and tax benefits. It provides an array of taxation alternatives while shielding individual members from personal liability.
