Why Should I Setup an LLC?

by Rob Jennings J.D.
LLC formation offers a host of advantages to the startup entrepreneur.

LLC formation offers a host of advantages to the startup entrepreneur.

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The limited liability company, or LLC, has gained popularity among startup entrepreneurs as a way of receiving flexible tax treatment and limited liability. While a sole proprietorship may offer more in terms of ease of creation and an S corporation more in terms of ability to transfer the business, the LLC makes sense for small businesses for a variety of reasons.

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Limited Liability

As the LLC is a separate legal entity, it stands as a shield between plaintiffs in lawsuits against the company or other members or employees and the personal assets of an innocent member. Although your business may have no employees at the present time and you may be the only person a potential plaintiff can sue, organizing as an LLC gives you the flexibility to hire employees and expand your business without exposing your personal assets to loss because of somebody else's wrongdoing. Although other forms of corporate existence offer this protection as well, limited liability is the main reason many entrepreneurs choose to organize as an LLC.

Flexibility in Tax Treatment

Members of an LLC can elect to receive pass-through taxation, which avoids the double taxation problems inherent in Subchapter C corporations. This enables the LLC owner to receive both limited liability and pass-through taxation without the requirements of organizing as a corporation and filing taxes as an S corporation under the Internal Revenue Code. With pass-through taxation, profits flow through the company and onto the member's individual tax return. Although this is also a feature of sole proprietorships, sole proprietorships offer no limited liability protection.

Simplicity in Documentation

While nothing can match the sole proprietorship in terms of the ease of setting one up, among entities that offer limited liability protection, nothing can match the LLC. Although the requirements for starting and operating an LLC vary from state to state, the forms are relatively short and simple. Many states offer online forms to help prospective LLC owners ensure that they comply with all requirements of state law. Unlike Subchapter S and C corporations, LLCs have no board of directors and no annual shareholder meetings.

Credibility and Asset Protection

While the LLC offers a host of other advantages, the startup entrepreneur should not discount the psychological advantages attendant to organizing as an LLC. Clients doing business with an LLC may feel they are dealing with a higher level of professionalism and legitimacy when their landscapers, plumbers or electricians are operating with "LLC" after their company name. LLCs also offer some protection for personal assets beyond the limited liability shield, as they are separate legal entities that can own property. As such, members can title their vehicles and other property to the business, possibly protecting it from suits arising from the members' activities outside the course of LLC business.