In the past, when people thought about starting a business, they often imagined a big corporation with lots of employees, strict rules, and a board of directors. Today, however, a lot of small businesses and startups are choosing a different business structure called an LLC, or Limited Liability Company.
There are several reasons why they prefer LLCs over corporations, from simpler management to tax flexibility and better personal liability protection. Let’s explore in greater detail why LLCs have become so popular in today’s business world.
1. Simpler Setup and Management
One of the main reasons people choose an LLC is because it’s much simpler to start and manage compared to a corporation. To set up a corporation, business owners usually have to follow strict rules, create a board of directors, hold formal meetings, and record minutes of these meetings. These requirements can be time-consuming and complicated, especially for small business owners who don’t need this level of structure.
With an LLC, however, the setup process is usually more straightforward. Many states only require a few forms to be filled out, and LLC owners, also known as “members,” generally do not need to hold formal meetings. This increased simplicity can save business owners time and frustration. However, it is strongly recommended that all LLCs maintain clear and comprehensive records and minutes of their management meetings be created. An LLC is a business after all, and that fact must always be kept in mind if its other benefits are to be achieved.
2. More Liability Protection
Both LLCs and corporations offer a significant benefit called “inside limited liability protection.” This means that if a lawsuit arises from the actions or assets of the company, the personal assets of the owners are generally protected. For example, if an LLC or a corporation is sued because one of its vehicles is involved in an accident or because an accident occurs on LLC or corporate property, the plaintiff in the lawsuit can usually only go after the assets owned by the LLC or corporation, and not the personal savings, car, or home of the members or stockholders.
However, there is a difference between corporations and LLCs in protection when it comes to the issue of “outside liability.” Outside liability arises when a problem is not the result of any actions or assets of the company, but is a result of a personal mistake made by of one of the owners. For example, an owner of stock in the corporation is in a car wreck and kills someone. In this situation, the stockholder’s assets are generally available to be seized by the plaintiff’s attorney – including their corporate stock!
And if the stockholder happens to own a majority of the stock, the plaintiff would then get control of the business owned by the corporation. If the business is an LLC instead, the plaintiff cannot seize the ownership of it and therefore, cannot get control of the business. This is the BIGGEST major benefit of an LLC for people who want a simple yet safe way to protect their personal assets.
3. Tax Flexibility
Taxation is one of the biggest differences between LLCs and corporations, and it’s a major reason why many people choose an LLC. Corporations can only be set-up as either “C” corporations or “S” corporations. With a C corporation, the business itself is taxed on its income, and the owners or shareholders are also taxed on the income they receive from the corporation. This is called “double taxation” and it can be costly for some business owners. With an S corporation, the income earned by the corporation flows through to its individual shareholders.
All corporations are C corporations by default unless they elect to be S corporations. However, federal law imposes strict limitations on when a corporation can be designated as an S corporation.
LLCs on the other hand offer more tax flexibility. By default, an LLC is considered a “pass-through” entity, which means that the business itself doesn’t pay taxes. Instead, profits and losses pass through the LLC to the owners (members), who report it on their personal tax returns. This means that there is no double taxation, which can save owners a lot of money. However, LLCs can choose to be taxed as a C corporation or an S corporation if it benefits them. In other words, they have the flexibility to adapt to whichever tax situation is more favorable. Creators of LLCs should always consult with a skilled CPA about which tax election to make, and they need to be aware that there are time limitations associated with making this decision.
4. Flexibility in Management and Ownership
There are strict management requirements associated with running a corporation, like having a board of directors and officers who make important decisions on behalf of the business. There are also rules about issuing stock and managing shareholders. These formalities can make running a corporation complicated, especially for small businesses that don’t need so much structure. Corporations are also required to hold annual meetings, keep extensive records, and file regular reports with the state. These requirements add extra work and can increase legal costs.
LLCs usually have fewer formal requirements. Most states do not require them to hold annual meetings or keep detailed records, although it is recommended that they do. Also, although some states require filing a regular report, others generally do not unless the LLC owes taxes.
LLCs offer much more management flexibility too. There are fewer formal rules to comply with compared to a corporation and LLC members are free to decide how they want to run the company. For example, they may choose to have one person in charge of the business or share responsibilities equally among themselves. This flexibility can make it easier to adjust as a business grows or changes over time. However, it is strongly recommended that every LLC prepare a Company Agreement (called an “Operating Agreement” in some states) that spells out “how the business will work” because otherwise the state where the business is formed has laws that govern LLCs and the provisions set out in those laws may not be advantageous for the owners. Also, the creator/s of an LLC should always consult with an attorney who knows the law regarding LLCs in the state where the business is being formed. Remember, although an LLC is less formal and more flexible than a corporation, it’s still a business and must be operated like one.
5. Attractive for Freelancers and Start-Ups
For freelancers and startups, forming an LLC provides them with a professional structure that can build credibility with clients and investors, who may feel more comfortable working with an LLC because it signals to them that the business is legitimate and solid, even if it’s small. This can be a big advantage for solo entrepreneurs or small teams trying to attract more clients or outside funding.
Furthermore, forming an LLC is usually less expensive than starting a corporation. This makes it easier for freelancers and new businesses to establish a professional structure without having to spend a lot of money. However, although they may be tempted to establish an LLC using an on-line service because the service costs just hundreds of dollars compared to the more substantial cost of hiring an experienced attorney, it bears repeating that an LLC must be created and operated like a business and creating one without proper legal counsel may not effectively achieve the results that the LLC’s creator intended and could leave that business owner vulnerable to a successful attack by a plaintiff’s lawyer or the IRS.
Bottom Line: LLC vs corporation
Overall, LLCs provide a simpler, more flexible, and more affordable option for small business owners, freelancers, and startups. While corporations are still a popular choice for large companies with complex structures and many shareholders, LLCs offer many advantages for people looking to start and run a business with less hassle. By choosing an LLC, business owners can get the benefits of limited liability, tax flexibility, and easy management without the extra requirements that come with a corporation.
With more and more people choosing to start their own businesses, it’s no surprise that LLCs have become the go-to choice.
This article was originally written on November 19, 2024.
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