Advantages & Disadvantages of Forming a LLC

When deciding what type of business entity to establish, a business owner should understand the advantages and disadvantages of each type. LLCs give you a great combination of flexibility and protection. They shield members from personal liability while affording them an array of tax options.

For more information on corporation formation, please visit our post on the Advantages and Disadvantages of Forming a Corporation.

ADVANTAGES

Limited Liability
LLCs are similar to corporations when it comes to limited liability for its owners, allowing its members to avoid personal liability, per se, for debts and court judgments incurred by the LLC.

Less Formalities
There are fewer formalities, such as necessary paperwork and state-imposed requirements, for owners to deal with when establishing an LLC as opposed to corporations. However, LLC formation requires the drafting of an Operating Agreement.

Tax Flexibility
LLCs provide its owners with greater tax flexibility than corporations as the IRS does not consider LLCs to be a distinct separate entity for tax purposes. As a result, the IRS will not directly tax the LLC, at least initially, giving the LLC members the flexibility of choosing how they want to be taxed.

Structural Flexibility
Unlike corporations, LLCs provide a flexible management structure that allows its owners to establish any any organizational structure agreed upon. On the other hand, corporations which must have a board of directors to oversee the major business decisions of the company and officers who manage the day-to-day affairs.

Credibility
LLCs provide a heightened credibility with potential customers, vendors, employees and partners as you have shown a commitment to your business.

DISADVANTAGES

Taxation
Depending on how the LCC members decide to be taxed, LLC profits could be subject to self-employment taxes (i.e., double tax).

Roles
While corporations have specific roles for its members, LLCs generally do not. This often makes it difficult for a company to know who is in charge. However, this can be minimized with a well-written Operating Agreement.

Investments
It is difficult to bring on investors if you form an LLC unless you will allow them to join as members of the LLC. This also requires amending the Operating Agreement.

Ownership Transfer
With corporations, shares of stock can be sold. On the other hand, LLCs require that all owners approve any ownership transfer and the Operating Agreement must be amended.