The Pros and Cons to Becoming an LLC

As if starting a business wasn’t challenging enough, trying to figure out whether or not you should incorporate your business and make it an “LLC” can be an extra-added headache you never imagined.

Let’s take a step back. Wondering what the heck an LLC is and why you may or may not need it. You’re not alone.

According to Peter Alizio, a New York CPA and ESQ, an LLC is the abbreviation for Limited Liability Company, which offers the company protection with the flexibility of a partnership.

Still confused whether or not your company should become an LLC? Take note of what these accountants say the pros and cons are of incorporation and filing for taxes as an LLC.

Photo Courtesy of Entity Magazine

When you start a company, it may be important to take your personal self out of the potential debts and liability of the company, so that you don’t destroy your personal piggy bank. If your company goes bankrupt or someone sues, your personal assets are kept out of the drama.

“Having limited liability protection is especially important if the person forming the business has a lot of assets to protect or if the business naturally has high risks associated with it (such as businesses in the health or food space),” says Pamela Kornblatt, the President of Tax Strategists, an accounting firm that provides personalized tax preparation and advice to startups, entrepreneurs, corporations and individual.

Photo Courtesy of The Balance

One thing you can delete from your to-do list if you become an LLC is the need to deal with corporate formalities that might not be present with your business or something you need to do in order to keep the lights on.

“An LLC will not have to deal with corporate formalities i.e. board of directors or annual meetings. Instead the LLC is managed by an Operating Agreement, which is similar to that of a partnership agreement,” says Alizio.

There is also a giant tax benefit when you decide to become an LLC. Think filing personal taxes is a giant Advil-Immune headache? Filling personal taxes and taxes for your business may be extra complicated. But becoming an LLC can streamline your taxes, especially if the LLC only has one member.

“For tax purposes, a one person LLC is called a "disregarded entity" (which means exactly what it sounds like it means, for the purpose of taxes the government disregards the fact that you have an entity),” says Kornblatt. “Rather than having a separate tax return as in the case of a corporation or partnership, a one member LLC is reported as part of the personal tax return (on a Schedule C) in the same way it would be reported if it were simply a sole proprietorship. As a result, a one person LLC results in less work for a person who prepares their own taxes and lower accounting costs if using a professional tax preparer.”

There’s a catch, of course, to your taxes. This is why it may be important to know that becoming an LLC is not your only option when It comes to selecting a formation for your business.

“While an LLC avoids the dreaded "double taxation" of a C-corp, income generated through the LLC is subject to self employment tax (a whopping 15.3%!),” says Kornblatt. “With an S-corp structure, an owner providing services must receive a "reasonable salary" subject to payroll taxes (in the place of self employment taxes) but any excess profits over and above the salary are not subject to self employment taxes. This can make for significantly lower taxes for some S-corps versus LLCs making the same net profit.”

Having a business on your personal return may be a flag for the IRS to audit you, which is why when you have a business, it is important to stay organized and keep all receipts.

“Having a business on a personal tax return, whether a sole proprietorship or one member LLC automatically increases the risk of the tax return being audited,” says Kornblatt. “Especially since a lot of business owners do not keep adequate records (keep your receipts!), the IRS is especially fond of asking for documentation to back up expenses claimed on a return. This risk increases as the income earned by the LLC increases. Corporations (S or C) of similar sizes have much lower audit rates. “

If you are looking for potential investors, establishing your company as an LLC may not be the best move.

“For entrepreneurs who may be looking to raise capital, an LLC may not be the right fit as many investors prefer corporate business structures, says Kornblatt.