Advantages of an LLC

updated January 22, 2024 · 3min read

When you're starting a new business, you have a lot of choices. You can follow the lead of many large successful companies and form a corporation. But you may also have heard that limited liability companies are good for smaller businesses.

For those thinking of starting an LLC, here are six of the main LLC benefits.

1. Limited personal liability

If your business is a sole proprietorship or a partnership, you and your business are legally the same "person." Your business debts are also your personal debts. And if your business partner or employee is accused of negligence, your personal assets might be at risk.

An LLC limits this personal liability because an LLC is legally separate from its owners.

LLCs are responsible for their own debts and obligations, and although you can lose the money you have invested in the company, personal assets such as your home and bank account generally can't be used to collect on business debts. Your personal assets are also generally protected if an employee, business partner, or the business itself is sued for negligence.

Ready to start your business? Plans start at $0 + filing fees.

2. Less paperwork

Corporations also offer limited liability, but they have to observe certain requirements that may not be well suited to a small, informally run business. For instance, corporations typically must hold annual shareholder meetings, make annual reports and pay annual fees to the state. They also tend to have substantial recordkeeping requirements.

In contrast, LLCs don't have to hold annual meetings and usually are not required to keep extensive records. In many states, LLCs do not need to file annual reports.

3. Tax advantages of an LLC

LLCs get the best of all worlds when it comes to taxation. LLCs don't have their own federal tax classification, but instead adopt the tax status of sole proprietorships, partnerships, S corporations or C corporations.

The Internal Revenue Service automatically classifies LLCs as either partnerships or sole proprietorships, depending on whether they have one owner or more than one owner. This means that LLCs can always take advantage of "pass-through" taxation in which the LLC does not pay any LLC taxes or corporate taxes. Instead, the LLC's income and expenses pass through to the owners' personal tax returns, and the owners pay personal income tax on any profits.

In contrast, traditional C corporations are taxed twice on distributions to shareholders: once at the corporate level and once at the individual level. S corporations avoid double taxation and receive pass-through tax treatment, but not all corporations are eligible.

Ready to start your business? Plans start at $0 + filing fees.

4. Ownership flexibility

S corporations enjoy pass-through taxation, but they have several ownership restrictions. For example, they can't have more than 100 shareholders, can't include foreign shareholders and can't have shareholders that are corporations. LLCs provide pass-through taxation without any restrictions on the number and type of owners they can have.

5. Management flexibility

Corporations have a fixed management structure that consists of a board of directors that oversees company policies and officers who run the day-to-day business. Owners, also known as shareholders, must meet every year to elect directors and conduct other company business.

LLCs don't have to use this formal structure, and an LLC's owners have more choices about the way they run the business and make decisions.

6. Flexible profit distributions

LLCs have flexibility in the way they distribute profits to their owners, and they aren't required to distribute them equally or according to ownership percentages. For example, two people may have equal interests in an LLC, but they may agree that one of them will receive a greater share of the profits because he or she contributed more money or labor in the business's startup phase.

Corporations, on the other hand, must distribute profits to shareholders according to the number and types of shares they hold.

An LLC's simple and adaptable business structure is perfect for many small businesses. While both corporations and LLCs offer their owners limited personal liability, owners of an LLC can also take advantage of LLC tax benefits, management flexibility, and minimal recordkeeping and reporting requirements.

Find out more about Starting a Business

Sole traders and partners in a partnership pay in the region of 20% to 45% income tax while companies pay corporation tax, typically at 19%. As long as corporation tax rates are lower than income tax rates the advantage will often be with a limited company.

As well as salary payments to employees, a company can also pay dividends to its shareholders. A shareholder director will therefore often choose to receive the most tax efficient mix of salary and dividends. Provided a minimum level of salary is taken, the director retains entitlement to certain State benefits without any employee or employer National Insurance Contributions being payable. The balance of remuneration is sometimes taken as dividends, which may suffer less tax than salary and which are not themselves subject to National Insurance Contributions. Dividends would, however, be liable to corporation tax within the company.

In another article, we explore the taxation of dividend payments.

Companies generally also have a more benign set of rules around allowable expenses and reliefs. There is a range of allowances and tax-deductible costs that can be offset against a company’s profits. Surplus profits can also be retained within a company to fund costs and invest in growth and development.

It’s also possible effectively to defer income to a later tax year. This might be advantageous when the withdrawal of further income this year would take you into a higher tax bracket.

You should always take professional tax or financial advice in the light of your specific circumstances, and this area is no exception. No advice is offered here.