Drawbacks of a Limited Liability Company

A limited liability company, or LLC, offers many potential advantages to small business owners. An LLC is easy to establish, and provides legal protection for the personal assets of its owners against liability stemming from business activities. Owners may be individuals, corporations or even other LLCs. Along with their advantages, however, LLCs have a number of drawbacks.

Self-Employment Tax Liability

The IRS considers individual owners of LLCs to be self-employed. The LLC does not file a corporate tax return; instead, its profits filter down to its respective owners, who report the income on their federal income tax returns. Self-employed individuals must also pay federal self-employment taxes to cover the portion of Social Security and Medicare payments that are normally covered by an employer. In addition, self-employed workers often must make estimated federal and state income tax payments, or risk incurring a penalty for underpayment when their file their tax returns.

Limited Life and Structure

If a member of an LLC dies or leaves the company, in many states the LLC dissolves as a result, according to Business.gov. The remaining members may form a new LLC or end their association. Owners must make special provisions to extend the life of an LLC in the event an owner dies or departs. LLCs that elect to form "S" corporations must obtain recognition as a corporation in the state in which the company is registered, then obtain "S" corporation status from the IRS. The IRS does not allow nonresident aliens, partnerships or corporations to hold ownership interests in an "S" corporation, and limits total membership to 100.

Other Legal Drawbacks

Some states do not allow the formation of single-member LLCs. Other states refuse to acknowledge the limited liability aspects of an LLC, treating members as sole proprietors or as members of a general partnership, with all the legal liabilities involved. Certain industries, such as banks and insurance companies, are prohibited from forming LLCs. General partnerships subject their members to joint and several liability for business-related actions. That is, the personal assets of individual partners are not protected against legal action taken against the partnership. This is true regardless of the actual size of the partner's initial investment in the business or how small the percentage of the business the partner actually owns. Because the LLC formation is relatively new, legal outcomes are less predictable than other forms of business entities with a more settled body of case law. Determining when LLC members might be found personally liable is an unsettled area of law and different states have found different reasons for holding members personally liable.

Other Financial Drawbacks

Although the federal government does not impose corporate income taxes on LLCs, many states impose franchise taxes or capital values taxes, according to The Free Dictionary. Many angel investors or venture capitalists are reluctant to provide funding for LLCs, which can make it difficult to raise large amounts of capital. Obtaining credit may also be difficult. Banks and credit-granting agencies may require the owners of LLCs to cosign for loans or debts, placing their personal assets in potential peril. This is especially true with start-up companies.