Advantages & Disadvantages of an LLC

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Below are the advantages and disadvantages of an LLC compared to other business structures.

Advantages of an LLC

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The owners of the LLC have protection from personal liability for debts and judgments against the LLC. An owner’s personal savings, home, car, and other assets are protected. The extent of this protection varies by state.

Pass-Through Taxation

The IRS does not recognize a specific tax treatment for an LLC. Instead, by default an LLC is taxed as a sole proprietorship if it has one member or as a partnership if it has more than one member. In both cases, the LLC’s profits and losses are passed through to the owner(s). Each owner reports their share of corporate gain or loss on his or her tax return and pays taxes for the LLC at his or her personal tax rate.

Partnership Taxation

You might be wondering in what proportion the profits and losses of the LLC pass-through to the tax returns of multiple owners. The most common basis is to divide shares proportionate to the ownership percentage of each member. One advantage of an LLC is to describe in the Operating Agreement some other basis of allocation.

Tax Flexibility

The IRS does not recognize a specific tax treatment for an LLC. Instead, by default an LLC is taxed as a sole proprietorship if it has one member or as a partnership if it has more than one member. Most LLCs stick with this default pass-through tax treatment when they are just starting out. However, as the business grows, an LLC can often save money by electing a new tax treatment with the IRS. An LLC elects S-Corporation tax treatment to start saving on self-employment taxes. Eventually the LLC elects C-Corporation tax treatments when the savings from income splitting and deducting benefits outweigh the additional cost of corporate double-taxation.

Number of Owners

In most states, an LLC can be owned by just a single member or have multiple members.

Protect Investors

Investors often require a business structure offering them limited liability prior to investing.

Administration

An LLC requires less record-keeping, administration, and formalities than a corporation.

Disadvantages of an LLC

Lack of Case Law

The first US LLC appeared in Wyoming in 1977. Adoption by states of the LLC structure continued into the 1990s. As such, compared to the history of case law upholding the protections of corporations, the history of case law upholding the protections of LLCs is still rather small.

Ample Governance

The flexibility with which you can specify in the LLC Operating Agreement the governance of the LLC is often an advantage; however, LLCs can run into problems when neither statutory code nor the Operating Agreement set forth ample provisions.

Choice of Court

LLCs are regulated by state law, but what about when you have a dispute crossing state boundaries? For the purposes of federal civil procedure, LLCs are treated as partnerships not corporations. One way this can manifest is it can restrict the choice of which state court will hear the dispute.

Attract Investors

While LLCs offer investors limited liability, investors might be more accustomed or comfortable investing in the established governance and structure of a corporation. Only corporations can pave the way to an IPO.

State Renewal Fees

Certain states require reports, filing fees, and franchise tax either annually, biennially, or decennially.

International Taxation

United States LLCs are often recognized as corporations in other countries where they will pay corporate taxes.


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