When to Form an LLC

by Rob Jennings J.D.
LLCs offer a host of advantages to the owners of new businesses.

LLCs offer a host of advantages to the owners of new businesses.

Jupiterimages/Comstock/Getty Images

The limited liability company, or LLC, provides a host of advantages to the start-up entrepreneur. Owners, called "members," enjoy the protection of limited liability against the torts that co-members or employees may commit and expose the company to suit. Members also enjoy the ability to receive pass-through tax treatment, avoiding the double taxation inherent to traditional corporations. A sole proprietor should consider forming an LLC under several circumstances.

Ready to start your LLC? Start an LLC Online Now

When You Will Have Employees

Although your start-up may begin in the basement of your home with you serving as the sole employee, your business may grow to the point where you need to hire some help. In this situation, an LLC can prove highly useful. Under the doctrine of respondeat superior, you are liable for the torts of your employees committed in the course of business. If you employ them through an LLC, however, the limited liability shield should protect you and your personal assets, provided you have followed the requisite formalities.

You Will Have Co-members

Just as an LLC protects you against torts by an employee in the course of business, it also protects you against torts committed by co-members. At common law, in an unincorporated partnership the partners in a business were all liable for each others' acts, exposing everyone involved to financial ruin. The limited liability shield provided by the LLC can protect you from civil plaintiffs injured by one or more of your co-members in the course of business. Provided you followed the law in forming and operating your LLC, your exposure should be limited to your investment in the company.

You or Your Co-members May Be Sued Outside the Company

The limited liability shield does not prevent anyone from suing individual members for their own torts, whether committed inside or outside the business. In a sole proprietorship or traditional corporation, a creditor can attach business assets or gain control of a debtor-shareholder's shares in a corporation, including management and voting rights. In many states, members in an LLC enjoy the benefit of "charging order protection" from external creditors, which limits a creditor to receiving an assignment of the debtor-member's share of the profits. The LLC can continue to operate without involvement by the creditor or the disruption of operations due to the seizure of assets. As such, if you or your prospective co-members are involved in activities outside the company that could lead to external liability, you may wish to form an LLC.

When an LLC Will Not Help

Although useful, an LLC will not produce a benefit for all entrepreneurs in all cases. In terms of taxation, forming an LLC yields little, if any, advantage over a sole proprietorship, as both are eligible for pass-through tax treatment and can take deductions for legitimate business expenses. The limited liability shield will not protect a member from liability for his own personal acts; as such, a single-member LLC with no employees will offer no liability advantage over a sole proprietorship. As some states do not provide charging order protection to single-member LLCs, the LLC may offer no advantage over the sole proprietorship or organizing as a corporation.