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National Small Business Week Kicks Off; Choosing a Legal Entity: the Limited Liability Company (LLC)

This week is National Small Business Week. For the wide variety of people considering starting a business, this week we'll detail the basic types of legal entities small businesses can use. To begin, we'll look at the advantages and disadvantages of operating as a limited liability company (LLC).

The SBA's National Small Business Week website offers webcasts of this week's speakers and events, which cover a wide variety of topics.

As discussed here, though a downturn is a tough time to start a business, many are doing so. Whether due to the loss of an old job or seeing new opportunities amidst the current tough times, an intitial step new business owners must take is choosing the form in which to structure their business. The menu is large: sole proprietorships, partnerships, limited liability companies (LLCs), corporations, and variants in between (such as S corporations).

So, what are the pro's and con's of operating as an LLC?

Advantages to operating as an LLC include:

  1. Limited liability. Like the shareholders of a corporation, the members of a properly structured LLC are generally protected from lawsuits and judgments against the company.
  2. Pass-through taxation. The IRS does not separately tax LLCs (like it does corporations). Instead, owners of the LLC report profits and losses from the business on their personal tax returns. The means LLC profits aren't "double-taxed."
  3. Management structure. The owners of an LLC have more flexibility than the founders of a corporation in structuring the company's management. An LLC may be managed by its members, or by a manager separately hired to run the business.
  4. Flexible profit and loss allocations. An LLC, unlike a corporation, need not allocate profits and losses to its members in proportion to their ownership interests. Generally, the members can allocate the profits and losses as they see fit.

Disadvantages include:

  1. Must have 2 members. Generally, LLC's are required to have two members (unlike S corporations, which may have just one shareholder).
  2. Profits taxed at self-employment rates. Though profits pass through the LLC (which itself is not taxed), members pay taxes at the self-employment rate on those profits.
  3. Less uniformity in state laws. As newer entities than corporations or partnerships, LLCs do not have the same level of uniformity in state laws. This can lead to some uncertainties for businesses wishing to operate across state lines.