What type of business organization has the advantage of limited liability?

When you're starting a new business, you have a lot of choices. You can follow the lead of many large successful companies and form a corporation. But you may also have heard that limited liability companies are good for smaller businesses.

For those thinking of starting an LLC, here are six of the main LLC benefits.

1. Limited Personal Liability

If your business is a sole proprietorship or a partnership, you and your business are legally the same "person." Your business debts are also your personal debts. And if your business partner or employee is accused of negligence, your personal assets might be at risk.

An LLC limits this personal liability because an LLC is legally separate from its owners.

LLCs are responsible for their own debts and obligations, and although you can lose the money you have invested in the company, personal assets such as your home and bank account can't be used to collect on business debts. Your personal assets are also protected if an employee, business partner or the business itself is sued for negligence.

2. Less Paperwork

Corporations also offer limited liability, but they have to observe certain requirements that may not be well suited to a small, informally run business. For instance, corporations typically must hold annual shareholder meetings, make annual reports and pay annual fees to the state. They also tend to have substantial recordkeeping requirements.

In contrast, LLCs don't have to hold annual meetings and usually are not required to keep extensive records. In many states, LLCs do not need to file annual reports.

3. Tax Advantages of an LLC

LLCs get the best of all worlds when it comes to taxation. LLCs don't have their own federal tax classification, but can adopt the tax status of sole proprietorships, partnerships, S corporations or C corporations.

The Internal Revenue Service automatically classifies LLCs as either partnerships or sole proprietorships, depending on whether they have one owner or more than one owner. This means that LLCs can always take advantage of "pass-through" taxation in which the LLC does not pay any LLC taxes or corporate taxes. Instead, the LLC's income and expenses pass through to the owners' personal tax returns, and the owners pay personal income tax on any profits.

In contrast, traditional C corporations are taxed twice on distributions to shareholders: once at the corporate level and once at the individual level. S corporations avoid double taxation and receive pass-through tax treatment, but not all corporations are eligible.

4. Ownership Flexibility

S corporations enjoy pass-through taxation, but they have several ownership restrictions. For example, they can't have more than 100 shareholders, can't include foreign shareholders and can't have shareholders that are corporations. LLCs provide pass-through taxation without any restrictions on the number and type of owners they can have.

5. Management Flexibility

Corporations have a fixed management structure that consists of a board of directors that oversees company policies and officers who run the day-to-day business. Owners, also known as shareholders, must meet every year to elect directors and conduct other company business.

LLCs don't have to use this formal structure, and an LLC's owners have more choices about the way they run the business and make decisions.

6. Flexible Profit Distributions

LLCs have flexibility in the way they distribute profits to their owners, and they aren't required to distribute them equally or according to ownership percentages. For example, two people may have equal interests in an LLC, but they may agree that one of them will receive a greater share of the profits because he or she contributed more money or labor in the business's startup phase.

Corporations, on the other hand, must distribute profits to shareholders according to the number and types of shares they hold.

An LLC's simple and adaptable business structure is perfect for many small businesses. While both corporations and LLCs offer their owners limited personal liability, owners of an LLC can also take advantage of LLC tax benefits, management flexibility and minimal recordkeeping and reporting requirements.

 The Sole Proprietorship

Single, small business owners often choose this type of business organization. It is not a legal entity separate from the business owner. In most cases, it is a fictitious name that someone does business under, such as Tim’s Plumbing Service. The name is just a trade name instead of a legal entity.

 
Advantages of a sole proprietorship include:

• Easiest, simplest, and least costly business entity to form and operate.
  
• Complete control and flexibility.
  
• You can register your name, obtain a business license, and begin conducting business.
  
• The business does not pay separate taxes. All income passes directly to the owner and is taxed at the owner’s personal tax rate.

Disadvantages of a sole proprietorship include: 

The main disadvantage of a sole proprietorship is that the owner has unlimited personal liability for all business debt.  If the businessis sued, the owner is personally liable. Therefore, the owner’s personal assets could be in jeopardy. Another disadvantage is that when the owner dies, the business terminates or becomes defunct.

A Partnership

A partnership is a separate legal entity created by two or more individuals who engage in business for profit. Partnerships are not difficult to set up and operate, but to protect each partner, a comprehensive partnership agreement should define each person’s interest, liability, and role within the partnership.

Advantages of a partnership include:

• Limited partnerships and limited liability partnerships offer some degree of liability protection for partners. 
  
• Partnerships are easy to maintain because they do not require annual meetings or minutes of meetings.
  
• Partnerships do not pay corporate taxes. The profits and losses pass through the business to each partner, according to the partner’s interest in the business.
  
• Can be used by professionals who may not be able to create an LLC.

Disadvantages of a partnership include: 

Individual partners may bear the liability for the actions of other partners.

• Partners may have unlimited personal liability for debts and losses, except in the case of limited liability partnerships and limited partnerships.
  
• If a partnership is created without a written agreement or a partnership agreement is poorly drafted, there could be significant disputes that may lead to costly litigation.

The Limited Liability Company

A limited liability company (LLC) is a legal business entity that is separate and apart from its owners (members). LLCs combine some of the best advantages of a partnership with the advantages of a corporation. Each state passes laws that govern the creation and operation of an LLC.

Advantages of an LLC include: 

• LLCs may choose to be taxed as a sole proprietorship (pass-through entity) or a partnership. 
  
• Owners have limited liability. They are not liable for the company’s obligations or debts.
  
• LLCs are relatively easy to set up through the state’s Secretary of State’s Office. Members are not required to conduct annual meetings and have very few ongoing formalities or corporate filings with the state.
  
• LLCs offer a great deal of flexibility in how the LLC is managed.
  
• LLCs can be converted to a corporation if the company outgrows the limitations of an LLC.
  
• You may create a single-member LLC or create an LLC with multiple members.

Disadvantages of an LLC include: 

• LLCs are typically not suitable for companies that want to seek venture capital or pursue an initial public offering in the future.
  
• Some professional groups may not be permitted to operate an LLC.
  
• Transferring an interest or accepting new members can be difficult, depending on the terms of the operating agreement.
  
• Members may be held liable for company obligations in some cases. 
  

The Corporation

A corporation is the most formal business entity. It is a legal entity that is separate from its owners (shareholders). In the eyes of the law, a corporation is a legal person. The shareholders elect a Board of Directors to operate the corporation. The directors, in turn, appoint officers to manage the day-to-day operations and make high-level decisions for the company.

Advantages of a corporation include: 

• Corporations have an unlimited life span. Shares may be transferred, purchased, and sold.
  
• Owners are protected from personal liability for the company’s obligations and debts.
  
• Corporations have several options for raising capital. 
  
• Corporations are the preferred business entity for public companies.

Disadvantages of a corporation include: 

• Corporations are subject to double taxation. A corporation must file a corporate tax return and pay taxes based on its profits based on the corporate tax rate. Distributions to shareholders are taxed at the shareholder’s personal tax rate.
  
• Setting up and managing a corporation is more difficult and expensive. Corporations require annual meetings, minutes of meetings, and other formalities.
  
• The periodic filings and annual fees for corporations can be burdensome and costly for some businesses.
  
• Much less flexibility because of regulations governing corporations.

Consult a South Carolina Business Formation Attorney

Choosing a business entity is a crucial decision. These pros and cons are not an exhaustive list of the reasons why you may or may not want to choose a specific business entity. Consulting a South Carolina business formation attorney before choosing your business form can help you avoid unnecessary costs and problems in the future. Schedule a consult with a member of our team at Willcox, Buyck & Williams, P.A. today.

Which business form has the advantage of limited liability?

What type of organization has limited liability?

Which type of business enjoys limited liability?