Most Significant Benefits of Forming an LLC

Taking a closer look at the limited liability company

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January 8, 2015

If you've been operating your business up to now without forming and entity structure, both the IRS and your state government default your company into either a Sole Proprietorship or a General Partnership. Although there are several different types of structures to choose from let’s take a closer look at the limited liability company (LLC).

The LLC is becoming a preferred entity structure among many small business owners.

It's a structure that is helpful from both a tax and asset protection perspective. A limited liability company may be a perfect structure for your company if you prepare to do the following.

  • Use it to purchase assets such as real estate, stocks, bonds or other securities
  • Have the optimum versatility to disperse earnings and losses among the owners (called Members).
  • Have Members that live in the United States

Instead of shareholders, an LLC has members, who either run the LLC or leave it to be handled by a different group of Managers, or Managing Members. Members and Managers are protected from liability in the same way that officers, directors and shareholders of corporations are. This means that as long as they are acting lawfully and in the LLCs benefits, they will not be liable for financial obligations or other liabilities sustained by the LLC. The most that you can lose as a Member of an LLC is exactly what you've put into it.

It provides the following four significant benefits:

  1. Flow-through taxation (i.e., the revenues and losses circulate through to the individual tax return of the LLC's Members), preventing the double taxation of C Corporations.
  2. An LLC allows you to protect its assets from lawsuit judgments against the LLC’s Members.
  1. Safeguard your house and individual assets without losing the IRS property owner deduction.
  2. Get estate planning and succession to your kids on a tax-free basis through gifting.

It is essential to keep in mind that as a limited liability company you do not pay separate taxes and don’t even file tax returns. Like an S Corporation, the net revenues of an LLC are dispersed to the Members in proportion to their individual ownership percentages. Members need to then declare and pay taxes on their individual share of the LLC's earnings in the same way that S Corporation shareholders do.

It's also a very popular structure for real estate investors and small business owners who hold residential, commercial and investment properties. You can get beneficial tax treatment with capital gains, making it a really appealing structure to not just hold property but other appreciating assets as well.

The limited liability company also has a unique legal defense in numerous states that corporations do not. If you are taken legal action against personally and own shares in a corporation, those shares can be taken and sold by a judgment creditor. This means that as a corporation there is the possibility that you may lose control over all assets in that corporation.

On the other hand, as an LLC, there are unique legal protections in various states that prevent a lender from taking a Member's ownership interests. The assets in that LLC remain safe. It’s important to note that not all states provide this level of protection, so talk to a legal consultant to see exactly what the status of LLC laws is in your state.

Since the federal government does not acknowledge LLCs for federal taxation purposes, each LLC is categorized in a different way depending upon the LLCs structure. In many cases, your small business can request how it prefers to file its return. LLCs can just be categorized as a corporation, partnership or sole proprietorship so you will need to fill out Form 8832 to categorize your LLC.

For a total list of types for Limited Liability Companies check out the IRS.gov website.