When you first make the choice to become self-employed, there are a number of resulting decisions to work thorough. Some choices are easy and others are more complicated, but navigating these decisions is an excellent proving ground for how ready you are to become an independent.
One of the most important questions you’ll consider is how to structure your business. One such avenue is an LLC.
An LLC is a business structure that provides a middle ground between operating a corporation and a sole proprietorship: it allows for the pass-through taxation of a sole proprietorship while also providing the limited liability of a corporation.
Because an LLC is not considered to be a separate entity, the company itself is not taxed and does not take on losses. Instead, all company profits and losses are reported on the personal income tax returns of LLC owners. At the same time, these owners are protected from personal liability, just like corporations.
These two main features can make LLCs a good business structure option for independent professionals. Here are four advantages to becoming an LLC.
Pass-through taxation is most commonly found in sole-ownership scenarios where generated income flows directly to the owner. This means that income is treated as the direct income of the LLC owner, with taxation “passing through” to their individual tax returns.
With an LLC, you do not incur corporate taxes as you do with other business structures, so you avoid the double taxation trap. Instead, LLC owners must report their share of profit and losses on their individual tax returns.
While LLCs owners are subject to paying self-employment tax—the Social Security and Medicare tax that would normally be paid by the employer and employee—on their personal income tax return, they can deduct half of self-employment taxes as a sole proprietor would.
Some states, such as New York, California, and Texas, may also charge extra franchise tax on LLCs, and most states have a higher state-filing fee on this entity format.
An interesting benefit to LLCs is that owners have flexibility when it comes to entity transformation. By default, a single-owner LLC is treated like a sole proprietorship, but a simple check-the-box form allows the company to be treated as a corporate entity for tax purposes.
This is a path that provides LLC owners growth and flexibility options should they need to transform from a sole proprietorship format. If you’d like to add an additional owner or owners to your company in the future, LLCs can also be classified as Partnerships without having to elect corporate filing status.
An LLC owner has limited liability, which means they are not legally responsible for business debts and obligations of the company. If a limited liability company is sued, the plaintiffs are technically suing the company, rather than the owners or investors of the company themselves.
So long as personal and business funds are not co-mingled, only the company is at stake in the event of debts, lawsuits, or other legal obligations, rather than your personal assets.
LLCs are simple and inexpensive to set up, requiring less paperwork than C and S Corporations. They don’t legally require annual-meeting recordkeeping, or formal meetings throughout the year like corporations do.
LLC owners can distribute profits as they see fit thanks to fewer restrictions on profit sharing. If your company has multiple owners or shareholders, you can choose how you’d like to distribute profits. Unlike corporations, you are not required to distribute profits equally or according to ownership percentages.
While self-employment tax can be an added expense, with an LLC you won’t have to worry about incurring corporate taxes as you would with other structures. LLCs are simple and inexpensive to set up, and owners enjoy personal legal protection. MBO can assist in setting up your LLC and electing corporate filing status.
Should you be interested in setting up your own LLC, give us a call. We’re happy to walk you through the process.
This content from MBO Partners does not constitute legal or financial advice.
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