Spending time to select the most appropriate legal form for your new business will pay many dividends over time. For a small business, the first choice is usually between operating as a sole proprietor or a partnership with other investors, or creating an entity that protects your personal assets. Corporations and limited liability companies are the most popular type of limited liability entities. Both protect your personal assets from creditors of the company, assuming you observe basic rules and formalities in running the company. This section highlights the advantages associated with a limited liability company.
A limited liability company (“LLC”) has members rather than shareholders, and issues membership interests. The member owners usually contribute cash, equipment or other property to purchase their membership interest. In many states, a member can contribute a promise to pay money such as a promissory note, as part or all of their contribution to purchase a membership interest. This cannot be done with a corporation. The amount contributed can vary between members. The share of profits and whether a member can vote can be different. This is normally a problem with corporations where the shareholders want to elect “s-corp” status so that all of the profits flow through to the shareholders and are not taxed at the company level.
An LLC can be managed by the members, acting together under the rules of the company’s Operating Agreement. It can also be managed by a manager, which can be one of the members or an employee hired by the Company.
The Operating Agreement of an LLC can set up almost any management and operating structure you care to devise. It will specify who is authorized to make day to day decisions, what vote is required to enter into specific types of contracts or sell company assets, and when the company may be dissolved. The operating agreement is an extremely important part of any LLC and should be carefully drafted by your attorney and updated as your business grows and changes. The Operating Agreement is frequently neglected in the excitement of starting a new business and the many demands on your time.
With LLCs as with other entities, the IRS now allows you to choose how the LLC will be taxed by filing a simple election form. By default, an LLC with 2 or more members is taxed as a partnership. You can elect to be taxed as a corporation, in which case you would also file an s-corp election. An LLC with one member is disregarded by the IRS as an entity. That is, you simply file a schedule for business income with your normal personal tax return. While there is no separate tax return for the single member LLC, your personal assets are still protected by operating as an LLC. Each option has benefits and disadvantages. An experienced business attorney, working with your accountant, can help you make the right decision for your business.
An LLC can potentially require less reporting and recording keeping required than a corporation. For example, in Missouri, LLCs are not required to file annual reports with the Secretary of State, unlike corporations. In Kansas, both LLCs and corporations file annual reports. With single member LLCs, you continue to file only your personal tax return. With both corporations and LLCs, the records of the company must be available to members. Whether specifically required by statute or not, both an LLC and a corporation should maintain a list of each member and manager’s mailing address, articles of organization, tax returns and reports, operating agreement(s), and other vital financial information such as cash contributions and accounting records.
This summary highlights the advantages of an LLC. There are circumstances where a corporation is a better choice. For example, an owner’s income from an LLC is all taxed as self-employment income. At a certain level of profit, an owner will pay less in taxes by creating an employment agreement with a corporation, and distributing profit above the amount of that salary as a shareholder distribution. A shareholder pays only income tax on a shareholder distribution, not social security or unemployment taxes. There may also be a difference in what deductible employee benefits can be offered by a corporation as opposed to an LLC.
When you are ready to start your business, you should seek the advice of an experienced business attorney. You can learn more about our Business Law attorneys here.
*This article is very general in nature and does not constitute legal advice. Readers with legal questions should consult with an attorney prior to making any legal decisions.
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