A limited liability company or LLC is a legal form of a private limited company in the United States. It is a hybrid business entity with some characteristics of both a corporation and a partnership or a sole proprietorship. To be specific, the business structure of an LLC combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. This legal form of a business can also elect to be taxed as an S corporation, C corporation, partnership, or sole proprietorship as long as a particular LLC qualifies under the desired tax classification.
The Pros: Advantages of a Limited Liability Company as a Form of Business in the U.S.
Critical to the advantage of a limited liability company is that it combines the limited liability of a corporation with the tax benefits of a partnership or sole proprietorship.
Below are the specific advantages of an LLC:
1. Limited liability: Owners or members of an LLC have limited liability. This legal form of business creates a legal distinction between the business itself and the personal assets of its owners. This means that unlike in partnerships and sole proprietorships and similar with corporations, they do not assume the risks for any debts or financial obligations and some acts incurred by their companies.
2. Flexibility in allocation: The amount of money members invest in an LLC does not need to be equal to their percentage of ownership. Portions of profits and losses can be assigned to owners using an operating and legally binding agreement. This also means that an investor can finance half of the business without necessarily owning half of the entire organization.
3. Taxation benefits: There is no double taxation or no need to pay U.S. federal tax if a particular LLC elects to be taxed as a partnership or sole proprietorship. Profits are taxed personally at the members. This is called pass-through taxation. Furthermore, each member of an LLC can write off his or her losses on his or her personal income taxes.
4. Freedom in management: Operating an LLC requires less administrative and paperwork. A limited liability company does not hold regular meetings nor issue stock certificates. Record keeping and auditing the financial statement of an LLC are less tedious depending on the requirements of the members. This is a considerable advantage of an LLC over corporations.
5. Flexible number of members: There is no minimum or maximum number of members in an LLC. This is similar to a corporation. Another interesting thing to note is that while limited liability companies can have as many members as desired, most states also allow a sole individual to create and operate his or her own limited liability company.
6. Corporations or partnerships can be members: Another advantage of a limited liability company is that legal entities like corporations or partnerships can also be part owners. This allows an LLC to secure financing an other resources from other legal entities. Note that some companies set up a particular limited liability company when forming a joint venture.
7. LLC can have a management group: Members of an LLC are free to hire a management group. This is similar to a corporation. Most of the decision-making in partnerships and sole proprietorships are made entirely by the business owners. A limited liability company can hire individuals to form a management group that will run the company under the oversight of owners..
The Cons: Disadvantages of a Limited Liability Company as a Form of Business in the U.S.
While the advantages of a limited liability company can encourage individuals to set up their business under this legal form and structure, it is also essential to note the disadvantages.
Below are the disadvantages of an LLC:
1. Self-employment tax: Professional firms like law or accountancy firms might find it preferable to set up their businesses under an S corporation. U.S. laws provide that profits of an LLC are subjected to self-employment tax of members. Owners of an S corporation are individually taxed based on their salaries. The remaining profits of an S corporation are subjected to income tax.
2. Paying franchise tax: Several states, including Alabama, California, Kentucky, New York, Pennsylvania, Tennessee, and Texas, levy a franchise tax or capital value tax on a limited liability company. This tax is the fee an LLC pays to the state for having the limited liability benefit. This is a disadvantage of LLC over sole proprietorship and partnership.
3. Difficulty in finding investors: Corporations can issue stock and corporate bonds to increase their funds. A limited liability company can have a harder time finding an investor and sourcing capital because their main access capital depends on the requirements of institutions such as banks and other lending entities, venture capitalists, or angel investors or individual investors.
4. Limited eligibility: Some types of businesses or businesses in certain industries and sectors are not eligible to structure themselves as a limited liability company under federal and state laws. This is primarily due to relevant regulatory oversights and compliance. Examples include banks, insurance companies, and medical or healthcare services companies.
5. Additional or higher fees: Another key disadvantage of a limited liability company is that it typically pays more business registration fees than partnerships or sole proprietorships. Note that sole proprietorship and partnership are the least expensive to set up and maintain. Some states require yearly renewal fees. But these fees are less than what C corporations have to pay.
6. Confusion across jurisdictions: Different states have different laws and regulations for limited liability companies. For example, the District of Columbia considers LLCs as taxable entities and subjects them under double-taxation. Taxing regimes outside the United States are likely to treat a limited liability companies in the U.S. as corporations.