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One of the simplest, most flexible business entities available in the United States is the Limited Liability Company, or the LLC. Many entrepreneurs choose an LLC because it provides limited liability to its owners (technically called ‘members’), meaning that any liability created by the company is limited to the company. The members’ personal assets are protected from all claims against the company.
Small businesses are a big target for lawsuits. According to a 2005 study by Congress, “small businesses bear 68 percent of business tort liability costs, but take in only 25 percent of business revenue.” It’s critical that you protect your personal assets in case your business is sued.
If you are running your own business, you will want a business entity that limits your personal liability for business debts. Partnerships and unincorporated businesses do not provide limited liability.
LLCs Get the Best of Both Worlds
You can think of the LLC as a hybrid between a partnership and a corporation. Like a partnership, owners of an LLC (called ‘Members’), can have income flow directly to them, avoiding the double taxation problems of a C-corporation. Like a C-corporation, every owner of an LLC has limited liability. In a partnership, one partner must act as a ‘general partner’, who is personally liable for all debts of the company. There is no need for a ‘general partner’ in an LLC.
LLCs Allow Flexible Ownership Structures
An LLC can have any number of members, and each can own any percentage of the company that the members agree upon (the total percentage ownership has to add up to 100%, obviously). Members can be individuals, other LLCs, trusts, and C-corporations. The variations are nearly unlimited, and people have come up with very inventive structures for accomplishing different tax and asset protection goals.
While S corporations avoid double taxation, there are severe limits to the ownership structure of S corps, including number of owners and what kinds of entities can be owners. For example, a corporation cannot be an owner of an S-corp.
In contrast, nearly any entity can own shares in an LLC. A corporation, a trust, an individual, another LLC, a partnership, or a limited partnership can all own interests in an LLC. This increases your flexibility for raising capital and creating joint ventures with investors and strategic business partners.
No Double Tax with an LLC
An LLC has much more favorable tax treatment than a corporation. Unlike a C-corp, LLCs don’t pay an “entity-level” tax. Profits and losses flow through from the LLC to the members directly. Corporations have to pay a tax first, then the owners pay again when they receive dividends.
LLCs are almost universally preferred for holding investment real estate, having replaced the limited partnership as the entity of choice. A consultation with an accountant or attorney will be helpful in making sure you realize the full tax benefits of this type of business structure. These include methods of minimizing self-employment tax, and ensuring smooth pass-through taxation of all profits.