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Local Business  » Should you use an LLC for your small business? Probably--and

Should you use an LLC for your small business? Probably--and

Article:

Accountants and attorneys love limited liability companies. But

do limited liability companies--LLCs for short--really make

sense for small business owners. Probably. And for two almost

unknown reasons.

The Big Legal Benefit of an LLC: Limited Liability...

The big legal benefit of an LLC is that limited liability

companies provide all the same liability protection as a

corporation--but with much less red tape. A regular corporation,

for example, requires regular stockholders meetings, a board of

directors, regular board meetings, and of course records of all

these activities and bodies. But a limited liability company

doesn't.

This legal liability protection provided by an LLC can be

extremely valuable. One local attorney I often collaborate with,

for example, tells his clients that an LLC protects business

owners from the worst case scenario--which in his mind is a

"slip and fall" accident on the business property.

With an LLC as the business owner, so says my attorney friend,

the "worst case scenario" is liquidation of the LLC. That

liquidation means the people who own the LLC wind up with

nothing--which isn't good. But all the owners lose is what

they've invested in the LLC.

In comparison, without an LLC, the business owner's "worst case

scenario" if there's a "slip and fall" accident is that the

owner can lose almost everything they own. In other words, the

business owners could lose not only their investment in the

business but many other assets as well.

Let me issue a caveat here, however. You may not get as much

legal liability protection from an LLC as you want or hope. Say,

for example, that you're repairing the roof at the business

location and that, unfortunately, you happen to drop a hammer

onto a customer's head during the roofing project. Your LLC

probably won't protect you from that sort of tort liability. In

other words, the customer can probably look not only to your LLC

for payment of damages related to the dropped hammer but also to

you personally.

And here's another example, which unfortunately makes things

even murkier. What happens if someone working for you, one of

your employees or subcontractors, drops a hammer on the

customer's? The LLC may offer you some protection in this case.

But you may still be personally responsible. The customer might

reasonably argue that you should have done a better job managing

the employee or subcontractor, for example.

If you're extremely concerned about the asset protection

features of setting up and operating an LLC, get an attorney

involved in your business planning. An attorney knowledgeable in

LLC and business law can help you increase the liability

protection that you gain from using an LLC for your business.

And this consultation doesn't need to be particularly expensive.

You may be able to buy an hour or two of time from a good local

attorney and get all your LLC- and liability-related questions

answers.

The Big Tax Benefit: Enormous Tax Flexibility...

A second benefit of LLCs relates to the income taxes that

business owners pay on profits and capital gains. A limited

liability company can be almost whatever tax entity it wants to

be for income tax purposes. A limited liability company that is

owned by one person can be a sole proprietorship, a C

corporation, or an S corporation. A limited liability company

that is owned by two or more persons can be a partnership, a C

corporation, or even an S corporation (if the LLC meets the S

corporation eligibility requirements). This second benefit of

the limited liability company means that an LLC can choose to be

taxed in whatever way is most favorable to the business.

For example, a very small real estate business with a single

member (LLC owners are called "members"), might decide to be

treated as a sole proprietorship for federal income tax

purposes. This decision to be treated as sole proprietorship

would keep the business's accounting very simple--and it would

also mean that unique tax planning opportunities available to

sole proprietorships can be used.

A larger business operation--perhaps one with several

partners--might decide to operate as a C corporation or as an S

corporation in order to take advantage of some of the unique tax

planning advantages of these entity choices. A C corporation,

for example, often lets businesses provide rich tax-free fringe

benefits to employees including shareholder-employees. And an S

corporation often lets a business dramatically reduce the

self-employment, social security and Medicare taxes paid on the

owner's profits.

While a limited liability company is not difficult to set up by

yourself--you can have the paperwork done less than a quarter

hour from now--you should be aware that paying a few hundred

dollars to an accountant to pick the right taxation for your new

LLC might be the best investment you ever make. It's common that

the right taxation choice for a new LLC can save the owner or

owners of a small business $10,000 to $20,000 annually.

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The Drawbacks of the Limited Liability Company Choice

When you consider the two big benefits of a limited liability

company--limited liability but with less red tape and tremendous

tax flexibility--you have almost the perfect business entity

choice. So an obvious question is "Why wouldn't every business

use an LLC or limited liability company?"

Perhaps predictably, there are some costs and headaches

associated with operating as an LLC.

An LLC may increase your banking, accounting and insurance

costs. For example, while the bank account for a sole

proprietorship or informal partnership may be free if you keep a

large-enough balance, the bank account for a limited liability

company probably won't be free. The bank may charge $10, $20,

even more each month.

While a sole proprietorship can keep its bookkeeping and income

tax return preparation very simple, an LLC probably needs to

file its own tax return if the LLC operates as a partnership, a

C corporation or an S corporation. And this LLC tax return may

cost anywhere from a few hundred dollars to a few thousand

dollars annually.

Finally, it's worthwhile to note that an LLC may involve several

hundred or even a few thousand dollars of startup expense. For

example, you may spend money on publications. You may buy the

services of accountants and attorneys. You will need to print

new letterhead, business cards, and envelopes (if you use these)

that use the new LLC's name in order to show the world that

you're now operating as a limited liability company.

So where does all this leave you? How should you balance the big

benefits of forming an LLC with all the costs and drawbacks?

Unfortunately, I can't give you a one-size-fits-all answer.

You'll need to carefully consider the benefits and costs as they

add up in your specific situation.

I will share these thoughts, however. In my opinion, an LLC is

uneconomical for very small businesses--such as the very

parttime, home-based business.

On the other hand, any time you've got a business that's the way

you're making a living, an LLC economically reduces business

risk and as an added bonus can even save the owners thousands of

dollars a year in income or payroll taxes.

About the author:

Bellevue WA tax expert &

CPA Stephen L. Nelson is the author of both Quicken for

Dummies and QuickBooks for Dummies and an adjunct tax professor

for Golden Gate University's graduate tax school.