5 Myths about Limited Liability Companies (LLCs)

What You Need to Know About Limited Liability Companies

LLC Myths
LLC Myths and Misconceptions. Hans Neleman/Getty Images

There is a lot of confusion among small business people about limited liability companies (LLCs). Here are some of the most commonly misunderstood "facts" about LLCs:

Myth 1: An LLC is a "limited liability corporation" and is the same as any other type of corporation.

An LLC is a "limited liability company." An LLC is similar to a corporation in its limitations on liability to the owners, but it has a different ownership structure (members instead of shareholders).

An LLC is not a tax entity; most LLCs are taxed as sole proprietorships (one member) or partnerships (more than one member). Some LLCs can elect to be taxed as a corporation. An LLC is formed with Articles of Organization, while a corporation is formed with Articles of Incorporation. While the two forms are similar in some ways, they are not equivalent.

Myth 2: I can set up my LLC in a state like Nevada and avoid paying income taxes.

It is true that corporations in Nevada don't pay income tax, but you can't just set up a corporation in any state. You have to have a business "presence" there {called a tax nexus), and you have to be doing business there. You must have an office there, sell something there, or have employees or facilities there. 

If you set up your LLC in Nevada, you must pay annual fees of $350. But, if your LLC is doing business in another state (say, California), and you have a tax presence in California, you must still have an LLC entity in California and pay the required state income taxes and fees.

 

While you might save on corporate income tax, you will pay to keep up the business entity in that state. Why not just play it straight and incorporate in the state or states where you are doing most of your business? Being tricky usually costs you more in the long run.

Myth 3: Corporations are a "safer" entity than LLC's for avoiding liability.

LLC's aren't called "limited liability" for nothing.

A corporation is a separate entity, and its liability is separate from the liability of the owners ​unless something happens to "pierce the corporate veil" and cause the owners and shareholders to be sued.

A limited liability company limits the liability of the owners to their investment in the company. Of course, any company can be sued, and there is no protection against illegal activities. If you are concerned about liability, check with your attorney and insurance advisers.

Myth 4: An LLC is a business entity for tax purposes.

An LLC is not a tax entity. How an LLC is taxed depends on how many members there are in the company. A single-member LLC is taxed as a sole proprietorship; a multi-member LLC is taxed as a partnership. An LLC can also elect to be taxed as a corporation.

Myth 5: The LLC form is just for small businesses.

Many large companies are LLC's, including Amazon and Chrysler. The LLC form is just as much for large businesses as for small businesses.

Disclaimer: My purpose is to provide general information about this subject to give you a basis for discussion with your tax and financial advisers. I am not a CPA or attorney, and I don't give tax or legal advice.

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