Is An LLC Right For You?

Federal Income Taxes, Financial Planning, Investing & Retiring, Taxes


What sort of structure makes the most sense for your small business – a corporate structure or a sole proprietorship? If neither structure fits you well, perhaps the best choice for you is a Limited Liability Company (LLC) – a structure that represents a middle ground between a regulated corporate structure and a simplified sole ownership or partnership.

As a sole proprietor or partner, you can avoid the expenses and regulatory issues associated with a corporate structure. The rules vary by state, but both C corporations and S corporations are generally required to file articles of incorporation, appoint directors, hold regular director and shareholder meetings, pay fees, and fulfill other regulatory filings and structural requirements from the incorporating state.

Why would a small business want such a structure? The primary reason is liability protection. Since corporations are separate legal entitles, the personal assets of an owner/shareholder are shielded from the debt responsibilities of the corporation. In a partnership or sole proprietorship, your personal assets (bank accounts, home, car, etc.) could be liquidated to cover your business debts.

Tax structure must also be considered. Sole proprietorships and partnerships are known as “pass-through” entities because the profits and losses are passed through to individual owners, reported as income/loss on the owner’s individual tax forms, and taxed at individual rates instead of corporate rates. S and C corporations are separate tax entities that must file their own returns independent from owner/shareholder individual returns.

Shareholders in C corporations face double taxation (on the corporation and as an individual shareholder), while S corporation shareholders operate as pass-throughs and are taxed only on the salary they receive from the corporation.

LLCs attempt to incorporate (pun intended) the best of both corporate and individual approaches. LLCs create a separate business entity to protect your personal assets from business debts while giving you flexibility in your structure and your tax status. You can choose to be taxed as either a pass-through entity or a corporation. However, LLCs can’t issue stock or sell shares to acquire capital. Should you need that capability, it’s best to move on to an S corporation (or if you plan to go public and/or have international investors, a C corporation).

To form an LLC, you must file certain documents with the Secretary of State’s Office in your state. You will need articles of organization (at minimum the name, address, and organizational purpose), and an operating agreement that outlines the operating rules for your LLC. Filing fees are required, along with taxes in some states.

You don’t have to have regular meetings, although it’s wise to do so for several reasons – including keeping potential creditors from going after personal assets. Failing to observe rules, mixing personal and business assets, or similar reckless behavior can allow creditors to “pierce the corporate veil” by suggesting that the LLC is not taken seriously.

The new Tax Cuts and Jobs Act dramatically changes the tax calculations, and it does so in an unclear fashion. Corporate tax rates (applicable to C corporations) were cut dramatically from 35% to 21%, but individual tax rates were only slightly reduced – closing the tax advantage gap for all pass-through entities. To extend tax savings to pass-through structures, a new code section was created to allow a deduction of up to 20% of qualified business income (QBI) from a pass-through structure.

This new deduction can make an LLC more attractive compared to sole proprietorships and partnerships, but there are limitations. Certain high-dollar service industries such as health, law, and financial/brokerage services are excluded if income exceeds $157,000 for individual filers and $315,000 for joint filers. At that point restrictions are phased in, until the deduction is completely eliminated at $207,500 and $415,000 respectively. The calculation of QBI and the subsequent deduction is complex and still under study by tax analysts. In addition, this new deduction is set to sunset at the beginning of 2026.

In short, if you choose an LLC, don’t base your decision solely on perceived tax savings from the new law – and, in any case, seek up-to-date advice from a qualified tax advisor before proceeding.

An LLC is often an appropriate choice for small businesses because it offers reasonable liability protection with a minimal amount of paperwork and regulatory burden. Consider the pros and cons of each structure – and if you aren’t sure, it’s best to start with a simpler sole proprietorship or partnership structure. If you find that a corporation is a better fit over time due to tax advantages, growth concerns, or the need for corporate protections, you can switch structures when the time is right.

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Photo ©iStockphoto.com/Ildo Frazao



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