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Benefits and Risks of Forming a Limited Liability Company

Posted by Keith Codron | Jan 30, 2020 | 0 Comments

If you have decided to start a business and are researching available types of business entities, you may have repeatedly come across the term, “limited liability company” or “LLC,” but you might not understand what this type of entity is or whether it is right for you. A limited liability company (LLC) is a business entity that protects its owners (referred to as members) from being personally liable for the debts of the business. This, however, is not what makes the LLC special; several other entities also offer this protection. The LLC is unique because it combines various characteristics of other types of entities which, in the aggregate, make it one of today's most preferred legal structures for businesses.

Benefits of an LLC

Limited Liability. The most recognized characteristic of an LLC is its limited liability protection. This benefit allows LLC members to demarcate their personal assets and those of the entity, thereby enabling members to pursue business purposes with reduced risk to their personal assets.

  • Pass-Through Taxation. Another benefit of the LLC is the opportunity to avoid double taxation.Unlike other limited liability legal entities, the LLC is not taxed at both the entity and ownership levels; it is taxed only at the ownership level. In other words, taxes of the business pass through to its owners. This unique benefit exists because the Internal Revenue Service does not recognize the LLC as a separate legal entity for tax purposes. By default, the IRS classifies a single-member LLC as a disregarded entity that is taxed as a sole proprietorship, and it classifies and taxes a multimember LLC as a partnership. While an LLC's default taxation is pass-through, an LLC may also elect to be recognized as a corporation for tax purposes. Note that if the LLC elects to be recognized by the IRS as a corporation, it will be subject to double taxation (once at the entity level, and a second time when the business income is distributed to its owners). Nevertheless, the ability to decide how to be taxed by the IRS is a very desirable feature of the LLC.
  • Customizable Management Structure. Unlike other business entities, the LLC does not mandate a particular management structure. Members can decide whether the company will be managed by the members themselves or by one or more managers (who may or may not be members). There is also no mandate regarding the number of people who can own or manage the LLC. The specific details regarding management are determined by the LLC's operating agreement or, in its absence, state law. This allows LLC members to choose the management structure that works best for their business.
  • Relaxed Compliance Requirements. An additional benefit of the LLC is less stringent compliance requirements. Unlike corporations, LLCs do not have required annual meetings and do not have boards of directors. The documentation and reporting requirements are also more lenient. As a result, smaller businesses that do not run complex operations can enjoy a legal structure which meets their unique needs. If LLC members want to add mandates to their company, they can do so in the operating agreement.

Risks of an LLC

The benefits and risks of an LLC are opposite sides of the same coin. Essentially, there is a cost for flexibility. Each business owner must analyze his or her own circumstances to determine whether the benefits outweigh the risks. The following are some of the key risks to consider:

  • Loss of Limited Liability. Although an LLC enjoys limited liability, poor practices could result in an LLC losing its liability shield. If a company fai

About the Author

Keith Codron

Keith Codron is an Orange County attorney with more than 40 years of experience in the field of trusts and estates. He has been certified as a specialist in estate planning, trust and probate law by the Board of Legal Specialization of the State Bar of California. Mr. Codron's practice is focused...

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