Sole Proprietors Are at Risk: Dissecting the Benefits of a Limited Liability Company
The decision to transition from sole proprietorship to a legal entity for business owners is an important decision. While some business owners feel that remaining a sole proprietor is easier, it affords them with zero liability protection. In a nutshell, this means that if you are a sole proprietor, you are personally responsible for your debts. In the long run, the safest bet is a legal entity.
Regardless of whether you are new in the entrepreneurship arena, or have been in business for a long period of time, a Limited Liability Company (LLC) can be a wise choice. As a sole proprietor, you may be interested in learning about the steps to form your business as an LLC. However, you may have thought that it requires too much; both time and money. Or, you may have thought that your business has to be a certain size to form your business as a legal entity. None of these are true. Let’s dissect what an LLC is so that you are educated about the key benefits of forming an LLC.
The benefits of an LLC outweigh those of a sole proprietor.
Asset Protection – Forming an LLC provides asset protection because your personal assets become segregated from the assets of the business. In the case of any litigation, your personal assets, such as bank accounts, personal property or automobiles are protected. This is not the case if you are a sole proprietor; your business is not separate from you or anything that you own personally.
Pass through taxation – The benefit of pass through taxation is a determining factor for many when deciding to form an LLC. Essentially this means that taxable income is passed through on an owners’ individual tax return. If your business is an LLC, you can choose to be taxed as an individual, partnership or corporation. Although there are times when members of an LLC may opt to pay taxes at the corporate tax rate, this is not the norm. An LLC gives you the option to choose how you will be taxed in a few different ways. After an LLC is formed, you would choose your tax classification. Here are some common IRS tax form names and classifications associated with the various tax filings and links to the IRS information and forms themselves:
- Sole Proprietor/Single Member – Form 1040
- Partnership/Multiple Member – Form 1065
- Corporation – Form 1120
- Entity Classification – Form 8832
Less Formality – An LLC is not as formal as a corporation and does not have as many associated requirements. As with a corporation, an LLC is not required to hold an annual meeting, maintain minutes, or establish company bylaws. In lieu of the meeting, minutes and bylaws, an LLC is required to maintain an Operating Agreement, which is the LLC’s governing document. This agreement outlines the rights, responsibilities and ownership of the LLC.
Flexible Management – An LLC can have flexible management. This means that the ownership interest is represented through members of the LLC. There are no limits on the number of members an LLC can have, unlike corporations, which have a boards of directors who oversee major business decisions.
Fewer Restrictions –There are fewer restrictions on the type of ownership and how many members are allowed in an LLC. This is in comparison to an S-Corporation, in which the shareholders must be United States residents and you are limited to no more than 100 shareholders.
Additional Food for Thought
There are no restrictions on the number of LLCs you can choose to form. Generally, businesses need to apply for an Employer Identification Number, (EIN). However, if you remain a sole proprietorship, you can only apply for one EIN using your Social Security Number. This presents a problem if you choose to create more than one company.
Would you like to learn more about forming an LLC?
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