Did you know that how your business is organized could be just as important as what you sell? That’s because the structure you choose will determine things like how you’ll be taxed and who is liable if something goes wrong. Some businesses start out as a sole proprietor then migrate to a Limited Liability Corporation (LLC) structure as the business grows. Others start as an LLC. Why the attraction to this structure? Take a look at the pros and cons of establishing an LLC.

The Basics of Establishing an LLC

What is an LLC?

An LLC is a legal business structure that combines desirable features of two other types of organizations. It maintains the tax advantages of a partnership and the limited liability of a corporation. One person or several individuals can form an LLC. Each is referred to as a “member.” The laws governing LLCs vary by state but all states recognize them. Here are some of the pros and cons of this structure.

Advantages

• Limited liability – Shields the owner’s personal assets against business debt and liability. If an issue arises, the LLC is held responsible, not the owner personally. That includes legal liability resulting from your actions or the actions of your employees.
• Tax treatment – The company is not taxed separately as a corporation. Instead, each member pays taxes based on their own personal income tax liability.
• Financial flexibility – Each member can contribute different proportions of capital and can allocate different percentages of profits or losses. It is possible for outside investors to contribute and not become an owner.

Disadvantages

• Limited life – When an owner leaves the LLC, the remaining members must meet any remaining legal and business obligations and close the business. They can start a new LLC or disband. You can address this weakness in the LLC’s operating agreement.
• Self-employment tax – Because they are not taxed as a separate entity, LLC members must pay self-employment taxes for Medicare and Social Security.
• Set-up costs – There are initial and ongoing costs for LLCs. These can include state filing fees, ongoing fees, and annual reports.

Establishing an LLC

If you decide to organize as an LLC, most states require you to complete the following:

• File articles of organization – This document formalizes your LLC and includes information like your business name, address, and members. In most states, you will file it with the Secretary of State.
• Create an operating agreement – An optional document that structures your finances and organization. It specifies each member’s interest, how you will allocate profits and losses, and members’ rights and responsibilities.

Consider the advantages and disadvantages an LLC can offer your small business. Before deciding, check with your legal representative and accountant to determine what is right for your business.