When Should a Business Consider Becoming an LLC?
< View All PostsIt is not a legal requirement to incorporate a business. You could run a sole proprietorship or a partnership without any other business designation. However, there are some situations (and lots of benefits) to forming a Limited Liability Corporation, or LLC. Understanding what those benefits are and how it could help your business can help you make a better decision about when and how to incorporate.
What Is an LLC?
An LLC is a type of corporation that has, as its name implies, limitations on key aspects. It is one of several forms of incorporation you can select from and often best when you may not want to fully incorporate. Here is a look at what these differences are.
A C Corp
A C corporation is perhaps the most common and default option. It allows for you to have any number of shareholders you like. That makes it possible for you to sell stock for your company to raise money if you want to do so. Corporations also pay taxes on the earnings. The shareholders within the company pay taxes only on their dividends.
An S Corp
The S Corp has a limited number of shareholders – no more than 100. Often, this type of corporation allows the company to organize with a single owner. This allows the company to gain corporate liability protection. In this situation, the company itself does not pay the taxes. Rather, this is a pass through company, which means that the business owner’s personal income includes all of the business revenue. You may be able to deduct some of that income on your federal return each year, which is not available to unincorporated businesses.
LLC
The LLC is a bit of both of these situations. It has a simpler organization than a large corporation. It also has liability protection for your personal assets from your business assets (which is very important when it comes to protecting them. Also, an LLC can be taxed like a corporation or a sole proprietorship, depending on the situation.
When Should You Form an LLC?
Learning when to form an LLC is important. Filing one is really dependent on your specific situation. However, as your business grows, filing one can provide ample protection for you from some of the risks companies have today. You can file at any time, but here are some reasons to do so (which can influence when it is time for you to do so).
Benefits of an LLC
Reducing Liability: Perhaps the most common benefit and reason people seek out an LLC is because it limits liability. That means that the members of the LLC (which may include the owner and other leaders) are not personally liable for the actions of the company. As a result of that protection, the members’ personal assets are protected from claims made against the business. That includes assets like homes and bank accounts. As long as you run your business properly and your personal and business financials are all kept separate from each other, you then maintain this protection.
Pass Through Taxation: Another core benefit of an LLC is that it offers pass-through taxation. That means that the profits go to the members. The government does not tax them at the company level. Rather, the members receive the profits and then are legally obligated to report those profits to the government on their federal income tax returns (your personal returns filed each year). That makes filing your taxes a bit easier, and if your business loses money, that may lower your tax burden.
Considering this, you may want to consider when to form an LLC based on your income and liabilities. It also helps to speak to a tax professional to discuss the specifics of your situation based on your business’s profits.
Should You Put Off Opening an LLC?
There are a few things to keep in mind as you consider this process. For example, there are limitations on when an LLC is used. It is possible that a judge can rule that the structure of your business does not provide you with protection for your personal assets.
The most common reason this may happen is if you are mixing personal and business assets with each other. That could make it hard to create a clear line of where your business debts are and where your personal assets lie. This may also happen if a judge suspects any type of fraudulent activity in your business.
It is also important to know that the IRS considers an LLC a partnership (even if it has just one member/owner) when it comes to taxes. That means it considers the business members to be self-employed. As a self-employed person, it is up to you to take personal responsibility for paying your Medicare taxes as well as paying into Social Security. These are called self-employment taxes and will factor into your earnings.
Also, note that when a member of the LLC leaves, passes away or otherwise is no longer associated with the LLC, some states require that the LLC be dissolved, though it can be possible to create a new LLC with the rest of the members.
Making the Decision of When to Form an LLC
Filing an LLC may be best if you are facing increasing debts and assets for your business that you want to keep separate from your personal assets. Additionally, you may not be ready to file as a C corp yet, especially if you do not want to sell stocks for your business.
You do not have to make the decision of when to file on your own. It is a good idea to speak to professionals, including our team at Eco-fyle, to get more information about your options. You will also find that we make it as easy as possible for you to start and manage your small business, including helping you with all paperwork your business needs to become an LLC if you decide now is the time to do so.
