Why Is an LLC the Best Business Structure? (5 Reasons)
A limited liability company is one of the best options when establishing an entity, especially when planning to start a small business and protect it from personal liabilities.
I did in-depth research and partnered with our business experts with over a decade of practice to give a more comprehensive answer to the question on the topic.
In this article, we will help you understand why a limited liability company is the best business framework for you. This ranges from touching into its advantages, both legally and in terms of tax repayment.
Quick Summary
- A Limited Liability Company (LLC) is the best business framework because it provides property security, tax flexibility, and management versatility to its owners.
- Limited liability companies can be either partnerships or sole proprietorships.
- In 2021, LLCs represented a significant 71.7% of all partnership returns in the U.S., contributing 25.5% of the total partnership profits, highlighting their efficiency and profitability as a business structure, according to IRS statistics.
- From my experience forming an LLC is a strategic choice for entrepreneurs due to its blend of personal asset protection and tax advantages.
Types of Business Structures
There are several types of business structures to choose from, each with its own advantages and disadvantages.
Here are some common business structures:
- Sole Proprietorship: A sole proprietorship is a business owned and operated by one individual. It’s the simplest and most common business structure. The owner has complete control but is also personally liable for all business debts and obligations.
- Partnership: A partnership is a business owned and operated by two or more individuals. Partners share profits and losses, and each partner is personally liable for business debts and obligations. This structure is ideal for businesses with multiple owners who want to share management responsibilities.
- Limited Liability Company (LLC): An LLC is a hybrid business structure that combines the liability protection of a corporation with the tax benefits of a partnership. LLCs are popular among small business owners and entrepreneurs due to their flexibility and ease of operation.
- Corporation: A corporation is a separate legal entity from its owners, providing liability protection and tax benefits. Corporations can be publicly or privately held and are subject to corporate tax rates. They have a more complex management structure with shareholders, a board of directors, and officers.
Why a Limited Liability Company is the Best Business Structure?
An LLC is the best business structure because it offers limited liability protection, tax flexibility, fewer formalities, and management versatility.
This makes it ideal for businesses seeking ease of operation and personal asset protection.
If there is only one owner of an LLC, then it will be treated as a disregarded entity (a pass-through tax entity) for tax purposes.
If a limited liability company is taxed as a partnership, any income or loss generated will be passed through to the owners of the LLC and reported on their personal returns.
However, if the LLC is taxed as a C-corporation or S-corporation, then the income or loss will still be passed through to the owners, but it will also be taxed once again at the individual level.
LLCs can avoid corporate taxes through pass-through taxation, allowing profits to be reported on personal tax returns.
LLCs are generally flexible. Unlike corporations, LLCs may allow for different ownership structures, such as allowing members to have unequal voting rights and unequal distribution of profits.
Additionally, in the case of an LLC taxed as a partnership, you may use different allocation methods to determine how income or loss is allocated.
What Types of Businesses Should Choose an LLC?
The types of businesses that should choose an LLC are small business owners, newly-formed entities, businesses with limited capital, and sole or multiple owners.
As mentioned, business structures are flexible. There are many ways to form an LLC, and it can be under any structure such as:
1. Small Businesses
If you have a small business and want to limit your own liability, then an LLC is one solution (although it won't eliminate all possible forms of liability).
It will not prevent you from being sued for some form of wrongdoing. However, it will help protect your personal assets.
2. Businesses with Limited Capital
From my own experience, I've found that businesses with limited capital may want to consider an LLC as a form of business organization.
This is because it is relatively easy to set up and less expensive than other forms of business such as corporations or S-corporations.
Moreover, if the LLC is taxed as a disregarded entity, you won't need to file separate personal tax returns for the business.
3. Businesses with Many Owners
In my journey as an entrepreneur, I've encountered situations where businesses such as general partnerships and limited partnerships may want to consider an LLC since it allows for multiple owners.
This may help protect partners with their own liability.
Limited liability companies are also popular among new businesses. You can keep your start-up costs low since there are fewer formalities.
It is easier for a limited liability company to raise funds than a corporation due to the flexible ownership structure and ease of the process.
This gives it a distinct advantage over other forms of business organizations.
"It's important to evaluate whether your business exposes you to potential liability and, if it does, whether you're financially prepared to bear that risk. If not, opting for a sole proprietorship or partnership may not be the most suitable choice."
- Jon Morgan, iCEO, Co-Founder & Editor-in-Chief of Venture Smarter
It's difficult to narrow down the types of businesses that can be LLCs.
Because it is a flexible form of business, any company may use an LLC, including:
- Consulting firms
- Marketing and advertising agencies
- IT firms
- Landscapers
- Contractors and Builders
- Restaurants
- Fitness studios
Advantages of an LLC
A Limited Liability Company has some benefits similar to corporations and partnerships.
In discussing the advantages of an LLC, it's essential to note that the business structure represented a significant 71.7% of all partnership returns in the U.S. for 2021, according to IRS statistics [1].
Furthermore, LLCs contributed 25.5% of the total partnership profits, showcasing a notable growth of 23.1% from 2019. This underscores their efficiency and profitability as a business structure.
When I decided to establish my venture, forming an LLC was a clear choice after considering its advantages.
Below are some of the benefits linked with limited liability companies:
1. Personal Asset Protection
Because it is considered a separate entity from the LLC owner, liability protection is one of the biggest advantages of forming an LLC.
This means that the business itself is its legal entity from the LLC members, so if you are sued or something goes wrong with your company, only the company's assets are at risk.
It does not mean you can conduct any activity without being held accountable.
If you sign for a loan, accept the responsibility on behalf of the company, commit insurance fraud, or commit any other illegal activity such as not paying off your business debts, you can be held legally accountable.
However, this does not mean that the asset protection is useless - creditors and injured parties cannot seize personal assets such as your house or car when they chase after money owed to them by your company's business debts [2].
2. Legal and Tax Advantages
Another advantage of running your business as a Limited Liability Company is that it can help you avoid double taxation.
Danya Shakfeh, an attorney at Motiva Business Law, explains that the IRS recognizes LLCs as disregarded entities, eliminating double taxation concerns [3].
In other words, it is subject to pass-through taxation - the problem with traditional S-corporation or C-corporation and limited partnerships is that owners are taxed twice on earnings: first, at corporate tax rates and then again on personal income taxes.
With a limited liability company, you pay LLC taxes only once because the company itself does not pay income taxes, but you pay self-employment taxes.
However, you must remember that any money earned by the company is also subject to personal income tax once it is distributed as dividends, so this isn't a big advantage.
3. Operational Flexibility
Limited Liability Companies are very easy to set up and operate compared to other corporations or partnerships where there are complex requirements related to the number of shareholders, voting rights, etc.
People who are starting a business can do it on their own, which is much easier than working with other partners or investors to set up a formal corporation.
Furthermore, if you are worried about liability, keeping your business as an LLC means you can always convert to a standard corporation after your business is well-established.
LLCs help protect business assets from personal liability, ensuring that your personal assets remain safe if the business assets are insufficient to cover debts.
4. Flexible Management Structure
An LLC has another major benefit - it allows the owners (called members) to manage their business independently without working directly with other shareholders or partners.
The agreement between the LLC owners also does not have to be complex since an LLC operates as Sole Proprietorships, and you can structure it in any way that works best for you and your business.
5. Credibility
Running a business as an LLC offers significant advantages in terms of customer perception and credibility.
Unlike new corporations or partnerships that may struggle to attract customers due to their lack of establishment, LLCs are recognized for their legal separation from their owners, reducing perceived risk.
This separation enhances the business's credibility with customers and suppliers, especially as it grows.
Duman Zhumagulov, the owner of BoxStar Movers, supports this view, noting that an LLC structure fosters professionalism and proper governance [4].
Disadvantages of an LLC
Some of the disadvantages linked with limited liability companies include:
1. Higher Costs
Running your business framework like an LLC means higher fees and paperwork compared to working alone or with one partner.
You will be dealing with lawyers, accounting professionals, and other high-cost specialists much more frequently for their professional services in the beginning when you are setting up your LLC, so this is one of the disadvantages [5].
According to Forbes, the ongoing operational costs for an LLC can be substantial, with annual state fees and taxes potentially increasing operational expenses by 10% to 20%, depending on the state's regulatory environment.
2. Neutrality
Although an LLC does not have the same level of tax benefits as a corporation, there are no major disadvantages in choosing this structure.
It is simply a matter of being neutral and whether you want to take advantage of the tax benefits of a corporation or the liability protection and operational flexibility that you get with an LLC.
3. Transferable Ownership
LLCs are not as transferable compared to other corporations. If you want to sell your LLC, it can be difficult to find a buyer.
This is because of the limited liability structure, which means that nobody will buy an LLC with just one owner since there is no legal separation between the business and the owner if they run into problems.
4. Investment Disadvantages
An LLC is not as attractive for investors as a corporation.
This means that it will be difficult to attract outside investments for your company, and you might be limited to operating with only one owner as a sole proprietorship.
Related Article:
Business Structure Comparison
Here’s a comparison of the different business structures:
| Business Structure | Liability Protection | Taxation | Ownership and Control | Management Structure |
| Sole Proprietorship | No | Personal income tax | One individual | Owner-managed |
| Partnership | No | Personal income tax | Two or more individuals | Partner-managed |
| LLC | Yes | Pass-through taxation | One or more individuals | Member-managed |
| Corporation | Yes | Corporate tax | Shareholders | Board of directors |
FAQs
Why Is LLC So Important?
An LLC is so important because it protects your personal assets at stake. This is because of the limited liability that the LLC provides.
And it's not just for investors; entrepreneurs also need this so other companies won't sue their businesses if something goes wrong with their products or services.
What Does an LLC Protect You From?
An LLC protects you from personal liability and double taxation. This means that liability falls on the business and its assets, not on you as an owner or on your personal property.
Can an LLC Have Members from Outside the U.S.?
An LLC can have members outside the U.S. This flexibility allows for international investors or partners to be part of the LLC, which is not always possible with other business structures.
This can be particularly advantageous for companies looking to attract foreign investment or operate on a global scale.
References:
- https://bigideasforsmallbusiness.com/what-irs-statistics-tell-us-about-partnerships-and-llcs/#google_vignette
- https://www.investopedia.com/articles/pf/08/asset-protection-business.asp
- http://www.motivalaw.com/
- http://boxstarmovers.com/
- https://www.forbes.com/advisor/business/what-is-an-llc/
