Drawbacks to an LLC

by Carrie Ferland

A limited liability company, or LLC, is a type of business entity available to for-profit entities in the United States. LLCs offer a variety of benefits to business owners who choose to operate as such, including various tax breaks and protection personal liability, making an LLC a popular choice for new small businesses. Unfortunately, LLCs also come with numerous disadvantages that can sometimes restrict or even outweigh the advantages.

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Eligibility

Not all for-profit entities qualify for LLC status, and state laws vary significantly, creating even more confusion for small and individual businesses. However, most states prohibit high-risk financial organizations from obtaining LLC status. These include lending institutions, insurance providers and investment firms.

Initial Expenses

The initial formation of an LLC is often cost-prohibitive, particularly for small businesses, which can put a great deal of financial strain on a start-up with limited or no outside funding. Many states also require yearly re-registration, which is another added expense that many new businesses simply cannot afford during their infancy.

Limitations

While a formal business registration, LLCs are strictly private entities -- no LLC may ever go public. This is extremely prohibiting for business owners who hope to raise revenue and equity by issuing stock to outside investors. Business owners who hope to go public will have to reform under another title in the future to quality, leaving the protections an LLC offers behind.

Limited Life

Successful business entities can last decades beyond the owner’s life, passed down through generations. LLCs, however, die with the owner -- or, in the event of multiple owners, upon the first death of only one. LLCs also automatically dissolve upon bankruptcy.

Interstate Recognition

There are no federal rules governing the formation of LLCs, and state laws vary considerably. Because of this, there is no universal recognition of LLCs between states, so an organization doing business in two or more states may be forced to operate under different names or even under different laws. Further, a few states, including Virginia and the District of Columbia, do not acknowledge the traditional formation of LLCs, which could force organizations operating in multiple states to file under a different formation in each jurisdiction.

Federal Recognition

The Internal Revenue Service does not recognize the concept of an LLC, which creates potential tax problems for LLCs with only one member. Credits and other tax benefits are only available to LLCs with at least two members on board -- not including employees -- so an individually owned LLC could be forced to file as a sole proprietorship and face substantially more tax liabilities than originally anticipated, all without receiving the added benefit of self-employment credits. Further, many LLCs fit into multiple tax categories, which is inherently confusing for even the most tax-savvy business owner.