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FAQ: What are the pros and cons of limited liability companies (LLCs)?


When starting a business or changing an existing one there are several types of business entities to choose from, each of which offers its own advantages and disadvantages. Depending on the size of your business, one form may be more suitable than another. For example, a software firm consisting of one principal founder and several part time contractors and employees would be more suited to a sole proprietorship than a corporate or partnership form. But where there are multiple business members, the decision can become more complicated. One form of business that has become increasingly popular is called a limited liability company, or LLC.

The LLC combines several favorable characteristics of a traditional partnership, in which all members are entitled to participate in the management and operation of the business, with those of a corporation, in which the owners, directors, and shareholders are generally shielded from liability for the corporation’s debts. The means that in an LLC, just as in a corporation, the personal assets of the business owners’ would generally be protected if the business failed, lost a lawsuit, or faced some other catastrophe. Members are only liable to the extent of their capital contribution to the business. In addition, members can fully participate in the management of the business without endangering their limited liability status.

When filing season begins, the profits (or losses) from the LLC pass through to its members, who pay tax on any income when filing their individual returns. In other words, income from the LLC is taxed at the individual tax rates. Income from corporations, on the other hand is taxed twice, once at the corporate entity level and again when distributed to shareholders. Because of this, more tax savings often results if a business formed as an LLC rather than a corporation.

Taxpayers should note, however, that Congress recently increased the top marginal individual income tax rate to 39.6 percent, has placed a .09 percent additional Medicare tax on wages over $200,000 (single taxpayers), and has imposed a 3.8 percent net investment income tax on higher-income taxpayers. At the same time, there is strong talk among members of both political parties of lowering the corporate rate from the current 35 percent to something around 28 or 25 percent to make the United States more competitive with foreign nations. If this happens, many highly profitable LLC businesses may need to rethink their situation and consider switching to a corporate form.

Forming an LLC involves many requirements, but the benefits can be substantial. Please contact us if you have any questions.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.