Like a corporation, owners of an LLC enjoy limited liability, which protects their personal assets from judgments and other obligations of the entity. If the LLC incurs debts or liabilities, the creditors are limited to the assets of the LLC. In the event the assets are insufficient to cover the debts of the business, creditors may not generally collect additional amounts from the members. By contrast, a sole proprietor is personally liable for all the obligations of the business. This means that sole proprietors risks everything they own to satisfy the debts or judgments of their respective businesses, including their homes, cars and personal savings and investments.
Limited Liability Companies can take these forms:
- Single Member LLCs
- Multiple Member LLCs
- Member Managed LLCs
- Manager Managed LLCs
Fewer Formalities Required
A Limited Liability Company also typically requires fewer corporate formalities, such as regular meetings of a board of directors and an annual meeting of shareholders, than either an S or C-Corporation. They do, however, require proper filing of Articles of Organization with the Secretary of State to be formed and the members of the LLC are required to enter into an Operating Agreement that governs how the LLC will be operated.
Pass-Through Tax Treatment
LLCs are treated as “pass through” entities under the Internal Revenue Code unless the members elect to have it taxed like a corporation. This means that the owners report profits and losses only on their own personal income tax forms and no separate entity level filing is required. If a C-Corporation earns a profit, that profit is taxed. If those profits are then distributed to its shareholders, the shareholders pay income taxes on those dividends. This is known as the “double tax” and, while there are ways for small businesses to legitimately avoid the double tax, LLCs that have pass-through tax treatment are not subject to it at all.
Flexible Allocation of Profits and Losses
Members of an LLC may generally agree to allocate profits and losses among themselves in any way they wish; they are not required to allocate them in proportion to ownership interest. This allows for more flexibility in separating ownership interest from distribution of profits from ongoing operations, which may be useful, for example, in businesses where some owners are actively involved in day-to-day activities while others are not. It also provides significant flexibility in tax planning for its members. Always check with your tax accountant or advisor when setting or changing allocations.
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