Should I Form An LLC? Here's The Basic Breakdown

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I adore checklists. Seeing all of my to-do’s neatly laid out helps me avoid that dreaded paralysis of indecision when it comes to starting something big. My affinity for listing pros and cons and weighing options has never been more helpful than after I branched out on my own as a freelance writer and began researching whether or not I should form an LLC, or if something like a S corp or sole proprietorship would be a better fit for me and my growing business.

When I dove into my initial research, I thought all I'd need to do was plug in my business information, compare my projections to a tax code table, and voilà! The perfect structure would be obvious. Instead, what I found was a dizzying variety of advice from accountants, small business owners, and fellow freelancers. Some of it was even contradictory to one another — which was a true treat to discover, let me tell you. Eventually I realized all of the different information actually gave me the flexibility to choose what I thought works best, which is how I wound up as a sole proprietor.

If you're about to branch out on your own and aren't sure which corporate structure is right for you, check out this guide on forming an S corp, or this guide for determining if you should remaining a sole proprietorship, and keep reading for advice on whether an LLC is right for your business.

What Even Is An LLC?

The Internal Revenue Service defines limited liability companies (LLCs) as "a business structure allowed by state statute. Each state may use different regulations, and ... a few types of businesses generally cannot be LLCs, such as banks and insurance companies." Since regulations on LLCs vary from state to state, the IRS advises narrowing your research to just your specific state's regulations.

"The LLC is its own legal entity doing business with its own tax ID number, instead of the owner's Social Security number — also like an S corporation," explains Ryan A. Woods, Esq. and founder of Where’s Legal?, P.C. law firm in Santa Monica. "One of the biggest differences between the S corp and an LLC is that S corps require more complex paperwork and compliance requirements, whereas an LLC is simpler and has more relaxed requirements."

What Are The Benefits Of Forming An LLC?

Similar to corporations, LLCs allow your personal finances to remain separate from your business finances, but there are a few differences. "Instead of shares and shareholders, LLCs have members and units — or percentages," says Woods. "Also, LLCs require much less paperwork and compliances than corporations, and are therefore much less expensive to begin and operate."

Some people may also see the flexibility of an LLC as a benefit, since it allows the owners to have a much less formal business operation from a paperwork standpoint, but still have the credibility of a corporation. "The biggest advantage of an LLC is it's allowed to pay out differing payments to the owners if it is set up that way," says Charles Read, CPA, U.S. Tax Court Practitioner, and President/CEO of GetPayroll.

Even if you form an LLC, some accountants may advise you to file taxes under a different corporate structure (like an S corp) for maximum savings. But of course, consult a trusted financial advisor if this is something you’re considering.

Quick Question: What If I Get Sued?

Unfortunately, there are a lot of reasons for someone to potentially come after you or your business, and LLCs provide peace of mind to people who fear litigation. The answer is in the name: limited liability. If you become an LLC, it separates your business assets from your personal assets. "As long as you’ve properly maintained your paperwork and compliance requirements, you are shielded from personal financial liability. Therefore, only the assets of your company are on the line," says Woods.

What Are The Cons?

For one, since LLCs by default are "pass-through" companies, "they are potentially subject to higher self-employment taxes if not filed as S corps, as owners of an LLC cannot be employees — unlike corporations where owners can be employees," explains Woods.

"There may be complexities with taking on investors, since selling units and percentages can get messier than selling shares," Woods continues. "Also, unless LLC owners file an S corp designation, they are considered self-employed, which can result in difficulties when applying for auto or home loans and credit cards, and can also result in higher personal income taxes."

You’ll also have to open a separate business bank account. Some banks require documentation like letters of incorporation, proof of an Employer Identification Number (EIN), and a few other materials.

Sounds Good. How Can I Get Started?

If you’re thinking of forming an LLC, start by consulting your local Small Business Association or Secretary of State website, as well as an accountant that specializes in small business to see what your state’s fees and rules are. Woods also recommends contacting an attorney with experience filing corporate paperwork in your state. Again, since different states have different laws and loopholes for corporate structures, be sure to brush up on your state and local regulations before filing any paperwork. Good luck!