Limited liability corporations (LLCs) have become "hot" during
the past decade, with more and more businesses adopting the
form. What's the appeal?
The biggest reason to switch from a plain-vanilla sole
proprietorship is to limit liability, as the name says. If
you're a sole proprietor, both your business and your personal
assets are at risk if someone sues you and wins a judgment
against you. Incorporating your business as an LLC puts a wall
around personal assets such as your house, retirement account,
or kid's college savings. Payment for business debts or legal
judgments can only be satisfied from capital paid into your
business. An LLC won't protect your assets if you personally
guarantee a debt, however. For example, a lot of loans and
lease agreements you might be asked to sign on behalf of your
company contain language stipulating that you will personally
guarantee the debt. If you sign one of those things, you lose
the protection afforded by the LLC.
How It Works
Under the LLC format, shareholders, or owners, are called
"members." Each member gets a percentage ownership, which can
be decided any way you choose. Most one- or two-member LLCs
manage themselves, but you're free to hire outside management
help if members are too busy working to keep a careful eye on
the big picture.
Unlike a traditional corporation ("C" or "subchapter S"), an
LLC doesn't have to slavishly match profits or losses to the
capital each member puts in. A member who's contributed 40% of
operating capital could, for example, take 50% of the profits,
depending on your setup.
Tax simplicity. You don't
have to file a separate business return with an LLC. Profits
and losses can be reported on Schedule C of your individual tax
return. If there's more than one person in your LLC, one more
piece of paper is required -- form 1065, which tells the IRS
how much each person earned. Also, there's no "double taxation"
-- taxing both your business and you as an individual -- as
there is with a traditional "C" corporation.
Of course, some aspects of operating as an LLC are less
appealing than others. A lot depends on your goals and the
amount of time you're willing to spend on corporate
housekeeping. Here are some things to keep in mind when
deciding if an LLC is right for you.
Paperwork. Every LLC has to
write an operating agreement and file forms with the state
corporation commission or secretary of state. This includes
legal papers such as "articles of organization" or a
"certificate of formation." The forms would include the LLC's
name, address, agent for service of process, and the names and
addresses of managers. Most states post the rules and required
You'll need to write an operating agreement listing the rights
and responsibilities of members. In a regular corporation,
these would be contained in the bylaws. Items typically covered
would include each member's percentage interest, how you'll
allocate profits and losses, rules for meetings and voting, and
"buy-sell" arrangements for members who leave the LLC.
Offering benefits. You'll
also need to decide how important it is to have fringe
benefits. Unlike a "C" corporation, an LLC cannot deduct
benefits like health insurance and a retirement plan as
business expenses. Incentives like stock bonuses don't work
well under the LLC format, because there's no stock. Of course,
in a small company, that may not matter at all.
Unlike a "C" corporation, an LLC is a "pass-through entity,"
the same as a partnership or sole proprietorship. Members of
LLCs have to pay Medicare and Social Security tax on their
entire share of the earnings. This includes salary and profits,
even if the profits are not distributed to you. Self-employment
taxes for 2003 are 15.3% up to $87,000 and 2.9% of everything
above that amount. Members who are not active in the business
may not be subject to this tax.
Something to Think About
An LLC is not for everybody. Only you, with the help of a
lawyer and accountant familiar with your business, can pick the
best blueprint for your company. Look at your own needs, talk
with other contractors, and run the numbers. You need to decide
if liability protection and flexibility in running the business
and allocating income have enough value to offset the tax
consequences (if there are any) and added paperwork. Then
follow through so your setup is legal.
Joan E. Lisanteis an attorney and freelance writer who
lives in the Washington, D.C., area.
Form Your Own Limited
Book and disk, by attorney Anthony Mancuso (Nolo, 3rd
edition, 2002), $44.99
A good all-around limited liability corporation
source, including an attorney-search feature