In a limited liability company (LLC) a member can be an individual or another entity. This type of corporation is recognized in every state and is considered a pass-through tax entity meaning the corporation pays no tax. In lieu of paying tax, the profits (or losses) are passed to the members in the form of a K-1 statement that each member files with his or her personal tax return—so no double taxation such as you see in some C Corporations.
Essentially, if you are a member of an LLC, you only have limited liability on company debt and your personal assets are usually protected. If, however, the limited liability company enters into a loan or contract that requires the members to sign personal guarantees, you may still be personally liable for some corporation debts.
There are pros and cons to the LLC, however; below, we’ll take a look at limited liability examples that work best for some companies more than others.
Best Bets for LLCs
It’s better to utilize a limited liability company for some businesses where an S Corporation or other type of entity isn’t the best choice. Some examples are:
- Entity Member – If you have an investor who wants to utilize his corporation to invest in your business, if you form an S Corporation, this is not allowed. An LLC will allow another entity to be a member and can be given power in the operating agreement.
- Individual Members – On the other hand, if you have many individuals who want to invest in your company and still have their personal assets protected, a limited liability company is a good choice as well.
- Small Businesses – If your business is small and will not have many partners, owners, or stockholders, the few owners that become members in an LLC can avoid double taxation.
- Draws vs. Salaries – In a limited liability company, members may take draws without suspicion from the Internal Revenue Service unlike an S Corporation where taxable salaries are favored.
- Short Term Endeavors – Perhaps you’ve got a great product and need some investors to get it off the ground and then intend to sell the product and its copyright or trademark. In this case you and your investors can reap the rewards of a limited liability company and when you sell the product the LLC can cease to exist and divide the final revenues.
- Franchises – Although some franchisors won’t allow their franchisees to incorporate as an LLC, most will. This can be advantageous to all members if a disagreement in the franchise agreement comes into play, especially with regard to liability to the franchisor.
- Member Transfers – Although a limited liability company basically ceases to exist if a member leaves, this type of entity does allow for member transfers. If you have a member you know will only be a member for a short time, once that member offers a first right of refusal to all other members to buy his or her share, the membership may be transferred to a new member.
- Recordkeeping – Unlike the C or S Corporations where recordkeeping can come with stiff rules, the LLC tends to be more lax.
When to Be Cautious
The above limited liability company examples are not for every business. Businesses that are large and have many members that include individuals, other entities, or many shareholders may want to consider a C Corporation due to its benefits where many stocks are issued.
A bad limited liability company example would be to set up a one-person LLC. The Internal Revenue Service doesn’t tax a one-person LLC as one might expect and treats it more of a sole proprietorship. In addition, there are not very many states that allow for a one-person limited liability company.
A family-owned business may not be the best limited liability company example if only for the reasons of salaries paid versus who is receiving dividends or draws—this can get confusing and if you don’t follow the rules, you could receive IRS penalties. On the other hand, if a spouse or life partner wants to form a two-entity LLC, this can be beneficial for both when it comes to protecting personal assets or if they wish to transfer their memberships to their children at some point.
To make sure a limited liability company is the right avenue for you to use to incorporate, ask a legal or tax professional. If an LLC is right for you, learn how to form an LLC right here on Bright Hub and skip the legal fees!