The Pros & Cons of LLCs

by Joe Stone

An LLC, or limited liability company, is a relatively new form of business entity that is a hybrid between a corporation and partnership. The major benefit of an LLC is that is provides its owners -- called members -- with the advantages of both a corporation and partnership, while avoiding the disadvantages of each. However, depending on the needs of your business, there are also disadvantages to the LLC structure.

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Personal Liability Protection

The primary advantage of an LLC is that it provides its members the same protection of limited personal liability as a corporation provides to its shareholders. This means that the personal assets of the members are protected from lawsuits to collect the LLC's debts and other obligations. Creditors can only sue the LLC for payment of a debt, not the individual members; however, some claims -- such as a tort claim arising out of a member's actions -- may not be protected.

Federal Tax Advantages

LLC members can choose their tax filing status because the Internal Revenue Code does not have a set filing status for an LLC for federal tax purposes. This allows members to avoid the double taxation faced by corporations, and choose to file as a partnership for a multi-member LLC or as a sole proprietorship for a single-member LLC. All LLC profits or losses flow through to its members, and the LLC itself does not face taxation.

State Tax Disadvantages

In contrast to the federal tax advantages, LLCs can be at a disadvantage with regard to state taxes. Some states treat LLCs like corporations by imposing income or franchise taxes. For example, California LLCs are required to pay an annual franchise tax fee which, as of 2010, is $800. This tax is in addition to the income taxes paid by the LLC members, which results in double taxation.

Legal Uncertainty

Because LLCs are a new form of business structure, there is uncertainty regarding the legal interpretation of LLC laws due to the lack of state court opinions. For example, one issue that may arise is the extent to which LLC members must observe corporate formalities, such as holding regular meeting and keeping minutes of meetings, in order to maintain limited liability protection. Although state LLC laws generally do not require LLC members to observe such formalities, creditors seeking member liability for an insolvent LLC may try to use a legal concept called "piercing the veil" typically used to hold shareholders liable for corporate debts. Whether or not LLC members will be exposed to such liability won't be known until there is sufficient case law addressing the issue.