Introduction to LLC Formation

If you own an unincorporated business--a business that operates as either a sole proprietorship or a partnership--you have two big problems.

Dangers of sole proprietorships and partnerships

The first problem: You are legally liable for the all the debts of the business. In other words, no matter what happens, in some cases no matter who is at fault, no matter what the amount, you are liable.

In a worst-case scenario, you could lose almost everything you have.

But that's not the only problem with operating a business as a sole proprietorship or partnership. In addition to the income taxes you pay on your business income, you also pay a second heavy tax on all your business profits, the self-employment tax.

Many small business owners, in fact, pay more in self-employment taxes than they pay in federal income taxes.

That's the bad news, so to speak.

Advantages of forming a limited liability company (llc)

Fortunately, you also have some good news. You can often fix both problems easily, quickly, and inexpensively.

How? First, you can setup a limited liability company and use it to run your business. This largely solves the unlimited liability problem. A limited liability company, or LLC, means you aren't liable for the debts and obligations of the business merely because you own some or all of the business.

Second, you can use a quirk of recent tax laws to select how your LLC is taxed. But let me explain.

A limited liability company, or LLC, lets its owners select the tax treatment they want for their business. For example, an llc with a single owner can be a sole proprietorship or a C corporation or an S corporation. An LLC with multiple owners can be a partnership,a C corporation or S corporation.

This tax flexibility means you can pick the tax treatment that saves you the most taxes. An S corporation, for example, can save a small business thousands of dollars a year in self-employment taxes. And a C corporation, as another example, can allow small business owners to pay generous tax-free fringe benefits to themselves which saves potentially thousands of dollars annually in income taxes.

So here's the bottom line: If you're starting a new business or if you operate an existing business, you must investigate the limited liability company option. You owe it to yourself. You owe it to your family.

A Final Clarification: Limited Liability Company vs. Limited Liability Corporation

By the way, let me also just clear up a possible confusion. Limited liability companies can correctly be called LLCs. But people just starting to investigate limited liability company formations sometimes use other incorrect labels to refer to limited liability companies. For example, the phrases "limited liability corporation," "llc corporation," and "llc incorporation" are all wrong because corporations are different from limited liability companies.

Similarly, phrases like "llc company" and "llc companies" are incorrect because they're redundant. The "c" in the acronym "LLC" or "llc" stands for "company."

Truly My Final Point: Would You Prefer a Corporation?

For all the reasons given here--and you may want to poke around a bit before you decide which type of limited liability entity you want--most small businesses and investors should use a limited liability company rather than a traditional corporation. However, some entrepreneurs and investors don't like to use the words and acronyms such as "limited liability" or "LLC" in their business name (often for marketing reasons). Rather, these business men and women prefer the words and acronyms like "corporation," "incorporated," "corp," "inc." and so forth.

If you're not so sure about using a limited liability company, or LLC, for your business, you should know that another affiliated web site which I've set up, Fast Easy Incorporation Kits, sells do-it-yourself incorporation kits for setting up a traditional-style corporation. Those kits include discussions of how corporations are treated for tax purposes and a description of the steps for making a subchapter S election for a traditional-style corporation.

 

Related articles:

What is a Limited Liability Company?
S Corporation Tax Treatment For an LLC
Which State Should I Use For My New LLC?
Using Quicken For an LLC's Accounting System