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 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 agreement. This also means that an investor can finance half of an LLC without necessarily owning half of the business.
3. Taxation benefits: There is no double taxation or no need to pay U.S. federal tax if an 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 writes 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, just like a corporation. Another interesting thing to note is that while an LLC 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 such as corporations or partnerships can also be part owners. Hence, this translates into expanding the ability of an LLC to secure financing and other resources to fund its operation or current and upcoming projects. Note that some companies use an LLC when forming a joint venture.
7. LLC can have a management group: Members of an LLC are free to hire a management group. 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.
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 such as a law or accountancy firm 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. In comparison, 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 to increase their funds. A limited liability company can have a hard time finding an investor and sourcing capital because unless they are able to satisfy the requirements of institutions such as banks, venture capitalists, or angel investors.
4. Limited eligibility: Some types of businesses are not eligible to structure themselves as a limited liability company. Examples of these 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. 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 jurisdictions outside the United States are likely to treat a U.S. LLC as a corporation.