Advantages & Disadvantages of a Limited Liability Corporation

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A limited liability company combines elements of a corporation such as limited liability protection with the informal operating structure of a partnership. LLCs have a separate existence from the members who create and operate the business. Forming and operating an LLC will have significant tax and legal ramifications on the owners of the business.

Significance

A major advantage of operating as an LLC is the personal asset protection provided. The members and managers of a limited liability company have limited liability protection against business obligations and debts. This means if the company gets sued, the person or business that initiates the lawsuit cannot pursue the personal assets of an LLC manager or member as compensation for the company's obligation. Since an LLC has a separate legal existence, the company will accumulate its own debts apart from the members and managers of the LLC. An LLC member has liability only to the extent of their investment in the company.

Considerations

A limited liability company that elects taxation as a corporation is at a disadvantage since the company will be subject to double taxation. The LLC is required to file taxes on the company's income with the Internal Revenue Service. The second tax occurs when distributions are issue to the LLC's members. LLC members are taxed at their individual tax rate when distributions are received from the company. This is in contrast to an LLC that elects taxation as a sole proprietor or a partnership. LLCs that elect taxation as a sole proprietor or a partnership are treated like pass-through entities. In this scenario, the LLC is not required to file taxes with the IRS on the business level. Instead, the member of the LLC are allowed to pass their portion of the company's profits and losses directly to their personal income tax return.

Benefits

There are a number of benefits when operating a limited liability company. Members of the company can decide if they want control over the company's day-to-day affairs, or if they want to appoint non-members to manage the LLC's daily affairs. This flexibility allows the owners of an LLC to choose how much they want to participate in the company's affairs. Another advantage of operating an LLC is that it provides personal asset protection without the formalities of a corporation. For example, corporations are required to record minutes from company meetings and create financial statements, whereas an LLC does not have to adhere to such requirements. A major benefit of an LLC is that the members of the company may divide the company's profits and losses in any manner. This means an LLC owner may own 45 percent of the business, but receive 55 percent of the profits.

Warning

A disadvantage of operating an LLC is that the company may automatically end if a member of the company decides to sell his portion of the business, or if a member abruptly passes away. In this scenario, the LLC must terminate its affairs, pay creditors, file dissolution documents with the LLC's state of formation and distribute the company's remaining assets to the LLC members. Also, a drawback of operating an LLC is that the members of the company are required to pay self-employment tax on income generated by the company.

Size

LLCs do not have any size or ownership restrictions. An LLC can be formed in any state, including the District of Columbia. In fact, an LLC can form in any state with just a single person, or an unlimited number of members may operate an LLC. Members of an LLC may be other LLCs, corporations, partnerships, individuals and foreign businesses. Since a corporation can be a member of an LLC, an extra level of ownership can be created that is able to provide fringe benefits like health care insurance, as explained by the Gaebler website.

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