Why a limited liability company is usually the right choice
You decided to start a business and now you need to set up your company. Maybe you spent some time researching, collected bad advice from friends and family, and yet still managed to narrow down your options to a corporation, a limited liability company, or a sole proprietorship (or partnership you are not the only owner of the business). Of course, there are other entity choices out there, but the majority of companies starting out select one of these company structures.
There 2 primary reasons for selecting the right business structure for you company: (1) to protect your personal assets from lawsuits against your company; and (2) to take advantage of the benefits provided to businesses in the tax laws.
Liability Shields
Let’s start with protecting your personal assets. If you select a corporation or a limited liability company, either structure will provide a liability shield between the obligations of the company (for example, if the company is sued for not paying its bills, or for not satisfying a contract), and your personal assets such as your home, car, and bank accounts that are in your personal name. This means if someone sues your company and wins a judgment against your company, they are limited to collecting against your company, and cannot come after you individually. However, there are 3 exceptions to this liability protection that you should be aware of. If you engage in criminal activity or fraud, then your liability shield will not protect you. The third exception is where you personally sign or guaranty an obligation of your company (for example, if you personally guaranty a loan to the company, or a lease).
In those scenarios, your personal assets are at risk, and you should consider some advance estate-planning to protect your personal assets. Keep an eye out for more articles and solutions on that topic in the future.
If you select a sole proprietorship or partnership, neither entity will provide you a liability shield and your personal assets are at risk.
Tax Treatment
If you select a sole proprietorship or partnership, the are each taxed as a “pass-through” entity. This means that the company does not pay taxes, and rather, all the profits and losses flow through to your individual tax return. If you select a corporation as your structure, then you have a choice to be taxed as a “C” corporation or an “S” corporation (you probably hear about S corporations when you were collecting bad advice from your family and friends earlier). If you wish to be taxed as a C corporation, that means your company will be taxed at the company level (different set of tax tables than how individuals are taxed), and when the company pays you (either wages or dividends), then you will pay taxes on that income as well. That’s right, double taxation. Believe it or not, there are some scenarios where it might make sense to be taxed as a C corporation, but you should check with your accountant on that (ask them about retained earnings). More popular is the choice to be taxed as an S-corporation, which allows you to avoid the tax at the company level, and instead only be taxed at your individual level (similar to a sole proprietorship or partnership). However, as an S-corporation, you get the added benefit of the liability shield (that do not come with the sole proprietorship or partnership), and you take advantage of ownership distributions free from self-employment tax or payroll tax. I may put together an article on that down the road, but for now, ask your accountant about that. Even with these benefits, I still find the corporation to be “clunky” due to some of the formalities still required by Ohio law, which is what brings me to the limited liability company, or the LLC.
The LLC, in addition to the liability shield discussed above, allows you to select WHATEVER TAX TREATMENT YOU WANT. Ok, maybe not whatever tax treatment, but you are allowed to decide whether you want to be taxed as a sole proprietorship or partnership, a C-corporation, or an S-corporation (and today’s tax laws allow you to change it down the road if you need to). The combination of liability protection and the flexibility to pick your tax treatment makes the LLC, in my opinion, almost always the best choice. Many businesses starting out will begin by selecting sole proprietorship or partnership tax treatment to take advantage of the tax losses that will flow through to their tax returns in the beginning, and as they start to become profitable, they then change to S-corporation taxation to take advantage of the distributions free from self-employment tax or payroll tax.
Ultimately, you have to decide which structure is the best one for your business (hopefully, after discussing with your accountant), but the limited liability company is a hard one to beat.
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