US Taxation Update: 7 Advantages of Forming an LLC

• As of 2021, there were over 31.5 million small businesses in the U.S (99.9% of all businesses).
• In the U.S, the number of small businesses has doubled since the early 1980s.
• Small businesses within the U.S occupy anywhere between 30% and 50% of all commercial space. This is estimated to involve 20 billion to 34 billion square feet.

A recent report published by the United States Census Bureau showed that there were over 440,000 business applications in June of 2021- the vast majority of which being Limited Liability Companies (LLCs). Needless to say, companies who use AI tools to help stay ahead with the workload have a leading edge.

A Limited Liability Company is a business model that offers business owners legal protection from any personal liability whilst still allowing them to benefit from a plethora of different tax benefits.

Many start-ups are consequently structured as LLCs so as to attain certain financial benefits that aren’t offered by other business entities. In essence, a Limited Liability Company ‘’blends’’ a variety of advantageous attributes of a: partnership, proprietorship, and corporation without a plethora of the drawbacks of these corporations.

This has meant that LLCs are generally considered to have the best business structure for small businesses- particularly in the U.S, due to their rather inexpensive and non-complex nature.

If you are looking for a business structure that can enable you to: a) protect your personal assets, b) grow your business, c) benefit from tax deductions, and d) increase your business’s credibility, then an LLC is likely the best option for you.

Below we will discuss the advantages of forming an LLC in a U.S Taxation Law context.

Advantages of Forming an LLC

1.Limit Your Personal Liability

Since an LLC is considered to be a separate legal entity from its owners or members, individuals involved cannot be personally liable for any company debt accrued or any legal liability that arises.

Even though an LLC owner may end up losing their capital contribution to their business- meaning their shareholder status, their personal assets- such as their bank account, home, or car will not be at any risk.

Of course, this doesn’t absolve LLC owners of all personal liability regardless of their circumstances; where an individual voluntarily and personally guarantees a business debt or negligently violates tort law in a way that directly harms a third party or breaches a specified legal duty, they will likely be personally liable.

2.Avoid Double Taxation and Pass-Through Deduction

Most ‘’conventional’’ corporations have to deal with the massive burden of ‘’double income taxation’’. This is a situation whereby a corporation’s profits are taxed once (as income), and then the company’s shareholders are taxed a second time on those same profits (dividends)- meaning the same ‘’pool’’ of capital belonging to the same ‘’pool’’ of people has been taxed twice.

Limited Liability Companies, on the other hand, adopt a ‘’pass through’’ system that allows specified profits to be taxed only one on each shareholder’s tax return.

Moreover, in accordance with the Tax Cuts and Jobs Act, LLC owners may be able to deduct a further 20% of their business income.

As The Really Useful Information Company (TRUiC) pointed out: Tax-related advantages were in fact among the most highlighted points. This transpired from the recent Zen Business Review which ranked the current best LLC formation services.

3.Flexibility in Sharing Profits

In the vast majority of times, businesses tend to share their profits based on the owner’s percentage of ownership interest or capital contribution. In a general partnership, partners usually attain an equal split of the company profits.

An LLC, however, can utilize its LLC Operating Agreement to retain a much higher degree of flexibility when it comes to determining the way in which profits are allocated. For example, an LLC member may voluntarily decide to give up a part of their share of the profits if another member voluntarily agrees to put in a prolific number of extra hours towards the company’s day-to-day operations.

4.Less Paperwork

Other business structures that offer limited personal liability- like corporations, usually have other requirements that involve a significant amount of legal rigmarole that- consequently, are usually unsuitable for the relatively small businesses.

Whilst corporations are legally mandated to hold annual shareholder meetings, pay annual fees to the state, and create annual reports, LLCs do not have to hold annual meetings, do not need to file any annual reports in a variety of different states, and are (generally) not legally required to keep extensive records.

5.Management Flexibility

Again, unlike corporations- who generally have a fixed and pre-set board of directors (who oversee company policies) and officers (who run the daily operations of the business), LLCs can generally use whatever formal or informal structure that they desire.

This is a massive benefit for a plethora of individuals, as it can allow them to have a lot more ‘’choice’’ and control in relation to how they run every single facet of their business.

6.Ownership Flexibility

Other business entity structures- like S corporations, can also enjoy the aforementioned tax-through taxation, but they have other ownership-related restrictions that LLC’s do not have to comply with.

For example, they cannot include any foreign shareholders, they cannot have shareholders that are corporations, and they cannot have more than 100 shareholders.

7.Heightened Credibility

This last point may be a bit self-explanatory, but forming your business as an LLC may make you more ‘’credible’’ in the eyes of your consumers- especially in comparison to a sole proprietorship.

Potential Disadvantages

Having said that, it should be noted that there are still a few disadvantages to forming an LLC depending on your situation.

Transferable Ownership

Transferring an LLC ownership is usually harder than with a corporation. This is because, with corporations, stock shares can be sold by the corporation (so as to increase total ownership) and- unless prohibited by a specified term in the shareholder agreement, the shareholders can then sell their shares to another person.

With LLCs, on the other hand, all members must approve of new members- unless they have agreed otherwise beforehand.

Increased Cost

Perhaps reasonable when considering the ample structural and financial benefits that it can provide, an LLC generally costs a bit more to form and maintain in comparison to a general partnership or a sole proprietorship.

Different states charge initial formation fees, but many also mandate ongoing fees (such as franchise tax dues).

Conclusion

Janet Yellen and the Feds under the current Biden administration may curtail these advantages quite soon - and perhaps on a global scale too. For now, we have delineated the prolific advantages that are associated with starting an LLC corporation, as well as some of the mild negatives. It should be duly noted, however, that individuals are always encouraged to carry out their own individual research before making a final decision.