Forming an LLC
While all types of entity structures serve a specific purpose forming a Limited Liability Company (LLC) for a small business is growing in popularity. It’s a structure worth looking into from both a tax and asset protection standpoint.
LLCs are great for businesses that:
- Are being used to invest in appreciating assets such as real estate, stocks, bonds or other securities
- Want to have the maximum flexibility to distribute profits and losses amongst owners (called Members)
- Anticipate that all of their Members will live in the United States
LLCs allow you to:
- Have flow through taxation (i.e., the profits and losses flow through to the personal tax returns of the LLC’s Members), avoiding the double-taxation of C Corporations
- Protect the assets of the LLC from lawsuit judgments against individual Members
- Protect your family home and assets without losing the valuable IRS homeowner deduction
- If set up properly, to allow for estate-planning and succession to your children on a tax-free basis through gifting
Instead of shareholders, a limited liability company (LLC) has members, who either operate the LLC directly or leave it to be managed by a separate group of Managers, or Managing Members.
Members and Managers are protected from liability in the same way that officers, directors and shareholders of corporations are which means that as long as they are acting legally and in the LLCs best interests, they will not be found liable for debts or other liabilities incurred by the LLC. The most that you can lose as a Member of an LLC is what you’ve put into it.
Most LLCs do not pay separate taxes and often don’t even file tax returns. Like an S Corporation, the net profits of an LLC are distributed to the Members in proportion to their individual ownership percentages. Members must then declare and pay taxes on their individual share of the LLC’s net income in the same way that S Corporation shareholders do.
LLCs are also ideal structures for holding real estate. They receive very favorable tax treatment with capital gains, which makes them very attractive business structures to not only hold real estate but other appreciating assets too. According to my good friend and entity specialist, Megan Hughes of U.S. Tax Aid, the three top reasons are protection, cost, and speed of creation.
LLCs also have a special legal protection in many states that corporations do not. If you are sued personally and own shares in a corporation, those shares can be seized and sold by a judgment creditor. That means you could lose control over all of the assets in that corporation. But an LLC, on the other hand, receives special legal protection in many states that prevents a creditor from seizing a Member’s ownership interests. The assets in that LLC stay safe.
Not all states offer this level of protection, so you might want to discuss things ahead of time with your legal advisor to see what the status of LLC law is in your state.
If you’ve been doing business up to now without a business structure, both the IRS and your state government default your business into either a Sole Proprietorship or a General Partnership so consider forming an LLC and avoid putting your personal credit and assets at risk.
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Marco Carbajo is a business credit expert, author, speaker, and founder of the Business Credit Insiders Circle. A business credit solutions membership helping business owners build small business credit. He is a business credit blogger for AllBusiness.com, a subsidiary of Dun and Bradstreet and author of “Eight Steps to Ultimate Business Credit” and “How to Build Business Credit with No Personal Guarantee.” His articles and blogs have also been featured in American Express Small Business, Business Week, The Washington Post, The San Francisco Tribune, Scotsman Guide, Alltop, Entrepreneur Connect, and Active Rain.