In other words…there are many types of business entities! When should you choose to form an LLC compared to your other entity options?
A commonly asked question among budding entrepreneurs is if they should form a Limited Liability Company (LLC). Forming an LLC is a popular route to take when choosing a business formation entity. It’s not the only choice and it may not be the absolute best choice for you and your business.
Definition of Entities
In order to discern if forming an LLC is right for you, it’s important to fully understand other entities. Know the pros and cons associated with each.
- Sole Proprietorship – This is the simplest business structure. The business is owned and run by one person with no distinction between the business and individual. You can choose to run a sole proprietorship under a trade name or DBA (doing business as) name.
PROS: Sole proprietorships are easy and inexpensive to create. The owner has complete control over the business, and it has the lowest tax rates of all business forms.
CONS: The owner is personally liable for any debts or obligations. It is usually difficult to raise capital, and the business literally dies with you.
- Partnership – A partnership is similar to a sole proprietorship, only the ownership is divided between two or more people. They each contribute financial resources, property, labor, skill, and they share all of the losses and profits that come with the business venture.
PROS: Partnerships are simple and inexpensive to form. There is an ease of capital acquisition due to shared financial commitment, and each partner contributes a unique skills set.
CONS: As a partner, you are not only liable for your actions, debts, and obligations of the business but also for the other partners. Personal disagreements can also occur between partners. The profit and success is shared between the partners even if some aren’t pulling their weight.
- S-Corp – The IRS will designate some corporations as S-Corps to allow them to avoid double taxation (once to the corporation and once to the shareholders).
PROS: One advantage of the S Corporation is that like the LLC it receives pass-through taxation.
CONS: S-Corps have more operating requirements and ownership restrictions than an LLC.
- C-Corp – A C corporation, or C-Corp is often called a generic corporation. It is the oldest and one of the most common business entities. A C corporation is a completely separate legal entity from its owners. It is also taxed separately. The business itself is legally liable for actions and debts rather than the shareholders.
PROS: While all business entities can provide fringe benefits to its owners and/or employees, the Corporation allows for a greater range of fringe benefits. Forming a C-Corp is also advantageous to corporate tax treatment and income splitting. The tax rate on corporate income is usually lower than the tax rate on personal income up to the first $75,000 in income.
CONS: C corps will have a board of directors, which means the business owner will have less control. Every major decision will have to be passed by the board.
- Nonprofit – A Nonprofit corporation’s principal purpose is public benefit- dedicated to giving back in some way.
PROS: Nonprofits are eligible for tax breaks. If classified correctly with the IRS, nonprofits are exempt from federal, sales, and property taxes.
CONS: Due to regulations to maintain the nonprofit status, personal control is limited. Finances of a nonprofit are also open to public inspection which can be detrimental to the nonprofits image and credibility.
- LLC –The LLC or Limited Liability Company is the newest form of business incorporation, and is often described as a combination of a corporation and a partnership. Over 80% of small businesses are LLCs.
PROS: This is the simplest way of structuring your business to protect personal assets. With less requirements and more flexible ownership options than the other entities, LLCs provide business owners with limited liability protection. This means that the company assets are typically owned by the LLC and are separate from the personal assets from that of the LLC owners.
PROS: LLCs run into challenges when it comes to securing investors. Usually investors may be more comfortable with investing in more widely understood and recognized corporate formations.
Is an LLC right for you?
An LLC is a great option for those who want to minimize risk when starting their business along with more management flexibility and less complex tax filings. If you happen to go into debt, your personal assets are protected and won’t be used to pay for outstanding business expenses. Additionally, your net income or loss is “passed through” to the personal income of the owner or member, and is simply taxed as personal income for state tax returns and federally taxed as a partnership (in the case of a multi-member LLC) or as a sole proprietor (in the case of a single-member LLC).
Often new entrepreneurs think that forming an LLC is a must. While this is the simplest way to structure your business, it may not be the best for your business. If your key concern is personal liability for business issues, you can just get business insurance. Depending on where you live, it could be cheaper than filing LLC paperwork. Take time to consider how prone to lawsuits your industry is. Also, take a look at your key competitors to see how they’ve structured their business.
You have lots of options. While some entities are less common among entrepreneurs, they may offer certain tax benefits/breaks for profitable businesses.
Keep in mind that establishing an LLC does not have to be done in the first year. You can always re-evaluate as your personal or business situation changes. It’s not uncommon to operate as a sole proprietor for the first couple years before adopting a business structure for tax planning reasons once profits are noteworthy.
Pro Tip: Business formation can be tricky and the process gets bogged down with legal jargon. Do your research and ask as many questions as it takes to fully understand. Click on the entity title in this post for quick infographic cheat sheets for each entity.
LegalZing specializes in business formation and would love to provide you with the options that are most suitable for your business. You don’t have to be in this alone, let LegalZing join your team.