When you start a new business, you are confronted with a choice – what type of business entity to employ? The most common business entities among small businesses are sole proprietorships, limited liability companies, and S-corporations. Which one is right for you? This post will summarize the pros and cons of limited liability companies. Look here to learn about sole proprietorships. Click here for a post addressing S-corporations.
A single-member limited liability company (meaning it only has one owner) shares a lot in common with the sole proprietorship. Like a sole proprietorship, the LLC is very easy to operate – it doesn’t require a board of directors (though it can have one) or meetings of the board. As the owner, you can contribute to or draw funds from the company as you wish with no tax consequence. Additionally, the LLC member is not required to withhold or report payroll tax liabilities (except for other people employed by the company). Single-member LLC’s can also report their business activity on the individual return of the owner, just like a sole proprietorship.
The biggest advantage of a limited liability company over a sole proprietorship is right there in its name – limited liability. In general, the personal assets of an LLC owner are shielded from creditor claims arising from the business – adding a layer of protection for your bank accounts, automobiles, and real estate, among other things. Keep in mind, a court may still override that layer of protection, so it’s still good to have insurance and some risk tolerance.
The setup for an LLC is a little more intrusive than for a sole proprietorship. A certificate of organization or similar document (depending on the state) is required to be filed with the Secretary of State (in Idaho, the filing fee is just $100). An LLC generally must also obtain its own tax identification number – an EIN. That EIN will be used to open bank accounts as well as to file a tax return.
Multi-member LLC’s – LLC’s with mulitple owners – are required to file a tax return separate from their owners – form 1065 (like general and limited partnerships). The LLC does not generally pay any tax on its return, though it sometimes may elect to pay state income tax on behalf of its non-resident members. Instead, the income (and loss) from the LLC flows through to the individual returns of the members on a form K-1.
Once the K-1 hits the individual return of an owner-operator, there are plenty of taxes to pay. The profits from a limited liability company are taxed not only for federal and state income tax purposes, they are also fully subject to self-employment taxes. For 2014, the self-employment tax is 15.3% for the first $117k of profit, and 2.9 – 3.8% for profit in excess of $117k.
It’s legal disclaimer time: This post is informational in nature, and does not constitute legal or tax advice. We would, however, be happy to consult with you to determine which of the ideas presented here, if any, should be implemented in your specific situation.