Easy Guide to 4 Types of Business Structures: Limited Liability Company

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In my last two blog posts of this series, I was examining sole proprietorships and partnerships. Today I want to cover the topic of a limited liability company. While they are a step up from sole proprietorships and partnerships, the lesser ease and more expensive qualities of setting them up are more than compensated by the added protection.

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What is a Limited Liability Company (LLC)?

Invented in the early 1980s, a Limited Liability Company was an attempt to combine the benefits of a sole proprietorship/partnership with the protections of corporations. This structure is actually setting up a legal entity that can own assets and incur liabilities just like a living person. This legal distinction allows the limited liability company to own the assets and incur debt in the name of the LLC making the LLC liable for the debt and judgments, not its owners.

It also allows the owners to file a simple personal tax return like a solo or partnership that are pass-through tax structures for their ownership percentage, but also provides the corporate veil protections of liabilities of the company to personal assets of the owners.

{Just a side note, because it is so often mislabeled, there is no such thing as a Limited Liability Corporation (I even hear fellow lawyers say this- disappointing)}

Types of Limited Liability Companies

The owners of a limited liability company are referred to as “members”. LLC’s can be a single-member LLC (like sole proprietor) or a multiple-member LLC (like a partnership). As well, an LLC can be member-managed where one or more members manage the company, or manager-managed where the members hire someone to manage the day-to-day affairs of the company.

The relationship between the LLC members is defined by an operating agreement similar to a partnership agreement. There are no different types of members in an LLC, no “general” or “limited” members, like a partnership can have. The business itself is a created entity like a corporation so it must file for an Employer Identification Number (EIN) with the IRS, but it can choose its tax election.

Let talk about LLCs, Uncle Sam, and his Taxes

LLC’s and Income Taxes

When one sets up their LLC and files for an EIN, they will choose a tax structure election of either the pass-through like a sole proprietor/partnership or as a pass-through S-Corp. This election can be changed, but only once a year.

As a pass-through, this means that the owner(s) pays the taxes on profit (or deducts the losses) of their share of the business through their personal tax filing (1040 or 1040EZ) with the Schedule C for a single member, adding Schedule K if multi-member. Also, just like the sole proprietor/partnership, the owner(s) need to remember to pay “quarterly” estimated taxes.

This means that Uncle Sam isn’t going to wait until April when you file your 1040 and attachments to get his money. Each April 15, June 15, September 15, and January 15 you must send in an estimated amount of taxes for that year, and then by April 15th of the following year send in 1040 showing if you guessed right, overpaid and need a refund, or hopefully not underpaid and owe more (with a penalty if too grossly underpaid).

LLC’s and Self-Employment Tax

Since you are no longer an employee having these taxes held, you need to remember that you must pay Self-Employment tax which is your social security and Medicare taxes.

Self-employment taxes (at the time of writing this) are 15% of net earnings, divided as 12.4% for Social Security and 2.6% for Medicare. Remember this is over and above the income tax you pay, even though paid together in your quarter estimates.

Social Security is only paid on the first $137,700 (at time of writing) that is the owner’s share, so hopefully, you are killing it and getting to keep more of the “over” amount. Be sure to add to your 1040 (and other Schedules needed in your situation) a Schedule SE where you calculate your self-employment amount.

If you file as an S-Corp status (or change during the window to change), you are able to divide the profits the company makes into salary and dividends for the members. While you still pay everything tax-wise on the salary, you do not pay self-employment on the dividend portion. One must pay themselves a reasonable salary when deciding how to divide the profits. What is a reasonable salary depends on a lot of factors, not limited to just what the job is.

OK, Todd, What are the Advantages of a Limited Liability Company?

If you do everything as required, protections of the “corporate veil” just like a corporation to protect your personal assets.
As a pass-through entity, LLCs avoid double taxation corporations have to pay.

Alright, and What are the Disadvantages of a Limited Liability Company?

Depending on the amount of profit, the owner(s) could pay more than the current flat rate of 21% that is the corporate income tax rate.
Requires an Operating Agreement, even as a single-member LLC
At least yearly member meetings, with minutes taken, to retain corporate veil protections
Most states require yearly reporting to that state’s Secretary of State by a certain date to maintain good standing in the state.
Must keep all business and personal separate: including assets, liabilities, accounts, etc. to maintain the corporate veil. Not doing so allows the court to “pierce the corporate veil”.

End Results?

In my opinion, the LLC is the best of both worlds. An LLC is a simpler form than a corporation because there are no required by-laws or corporate charter. But that doesn’t mean that the LLC isn’t as carefully watch by federal and state government offices to make sure it is operated as a separate entity than the owner(s) and not co-mingled with the personal assets and liabilities.

It gives you the security of personal protection without double taxation and as many hoops as a Corporation does. It also allows you to file for S-Corp status (or change to it) giving you the chance to save on your taxes that sole proprietors and partnerships don’t.

It does add more work to the operation of setup and upkeep than a sole proprietor or partnership, but I think it is worth the extras for the protection. Look into all the business types and decide what is best for your situation.

If this is for you, here is how to set it up>>>

Decide the state you want to set up in. (99% of the time this should be your resident state)
Check to see if your name is available on that state’s Secretary of State site.
If it is, register the LLC with the state.
Then file in one of the easy ways for an EIN (business ID)
Create an operating agreement.
Using EIN, start to set up things that are needed to be kept separate from personal— like a bank account(s) and credit card(s) to name a couple.

If you missed my article on sole proprietorship, here is another chance.

If you missed my article on partnerships, here is another chance.

To see the next on the “Easy Guide to 4 Types of Business Structures” click the button below.

Series Part 4- Corporations