Warning: A Limited Liability Company May Not be the Best Entity for You
Using a Limited Liability Company Business Form Depends on More Than Avoiding Personal Liability
Are you considering starting a new business? Or do you have a business that is operating as a Limited Liability Company (often referred to as an (“LLC”) and considering changing to an S Corporation or a C Corporation? Whether you are starting a new business or already operating a closely held business, you probably did not consider all the ramifications and risks of the business entity form you selected. More than likely is that you never considered how the form of your business would affect your business exit strategy. This article will address some of the issues you should consider before you start your business.
Whether you are starting a new business or already operating a closely held business, you probably did not consider all the ramifications and risks of the business entity form you selected. More than likely is that you never considered how the form of your business would affect your business exit strategy. This article will address some of the issues you should consider before selecting a Limited Liability Company for your business.
When Creating a New Business, the Owner Must Decide Whether to Organize as a Limited Liability Company
Often I will talk with a corporate manager who wants to escape the corporate rate race and start his own business. He has completed an inventory of his skill set, reviewed his finances, and shocked his wife when he told her that he was quitting his job, starting his own business, and would need to use his retirement account or refinance the family home to fund his startup business. He is sitting across from my desk and finished telling me his story and concludes with “Russ, I need you to set up a Limited Liability Company for me.” The eager new business owner, let’s call him Dusty, may or may not have a business partner or his spouse may be involved in the business.
I want to know what Dusty has learned about business formation and structure that has led Dusty and maybe his partners to decide that a Limited Liability Company is the best business structure for his business. After all, I am sure Dusty has researched different business entities before reaching his decision that a Limited Liability Company is the best for his business. Why did Dusty select a Limited Liability Company?
Why Did You Organize as a Limited Liability Company?
What is the most frequent answer to my question? “Well, I was talking to my friend Charlene who has a roofing business or to my CPA, and she told me that when you start you should use a Limited Liability Company.” Now a little more fact finding. “Did Charlene or your CPA mention why they thought you should use a Limited Liability Company?” I can predict Dusty’s answer. “No, they just said when you start a business you always use a Limited Liability Company”, or “It will provide me with limited personal liability for business debts.” Dusty has overlooked other benefits of operating as a Limited Liability Company.
What are the Top 11 Benefits of Using a Limited Liability Company?
I asked Dusty, “What are the advantages of a Limited Liability Company?” Will Dusty identify the 11 advantages to using a Limited Liability Company for certain types of businesses? More than likely, Dusty will identify only at most name 2-3 advantages. The most frequently named advantages by prospective business owners is the limited personal liability and no double taxation. A Limited Liability Company can provide most of the benefits of a corporation.
Here are the top 11 advantages of a Limited Liability Company:
- Limited liability for all its managers and members;
- Possible protection from creditors and judgments through state charging order laws;
- Continuity of existence;
- Flow-through taxation at individual rates to members;
- A single member LLC owner is taxed as an individual;
- Avoids double taxation of profits;
- Provides limited privacy protection;
- A trust can be a member of an LLC;
- Member shares can be passed to heirs through lifetime gifting;
- Under existing law and regulations member interest can be discounted for estate tax purposes; and
- Management discretion on the allocation of profits and losses to members.
Dusty must also consider the disadvantages of a Limited Liability Company before he can make an informed decision. I asked Dusty if he was aware of the disadvantages. He gave me a blank stare. I proceeded to explain the limitations of the Limited Liability Company.
Did You Consider These 4 Limited Liability Company Disadvantages?
As with all business entries, a Limited Liability Company has some disadvantages. 4 of the most common disadvantages are:
- All income to members is subject to self-employment taxes;
- Transfer of a membership interest requires approval of existing members;
- Depending on the state, a single member LLC may lose some liability protections;
- Taxation of non–distributed profits.
In the author’s experience, most closely held businesses are initially operated as a Limited Liability Company. The second most used entity for closely-held businesses is a limited partnership. For the reasons discussed below, it is generally recommended that companies operate as an LLC when first starting out unless the non-managing partners are willing to not be involved in the day to day management of the business.
Share Your Additional Advantages and Disadvantages of Limited Liability Companies
The above advantages and disadvantages are the most common benefits and risks of using an LLC for your business. When you started your business your may have encountered other issues with operating an LLC. What other issues have you encountered?
Schedule a Free Consultation with a Beaverton Limited Liability Company Attorney
For more than 30 years Russ Pike has helped businesses and individuals in Beaverton, Salem and the Willamette Valley with their estate and business planning needs. Utilizing his experience as an Oregon attorney, Russ can assist you with your changing legal needs. Call Russ at 503.888.0952 or email at Russ@Pike-Legal.com to schedule a FREE Consultation.