Structuring Your Business as an LLC: A Guide for Business Owners

In our series on entity selection, we’ve explored several of the most common entity structures: sole proprietorships, corporations, and partnerships. Each offers a unique mix of tax and non-tax benefits, but there’s one entity structure that blends many of the advantages of a flow-through entity and a corporation: the LLC. 

Limited Liability Companies, more commonly known as LLCs, are entity structures that are permitted by states. From a federal tax perspective, LLCs are treated in a variety of different ways, depending on their makeup and how they elect to be taxed. 

LLCs are a popular choice for many business owners, offering a unique combination of liability protection and flexible tax planning opportunities that can be tailored to the needs of the business and its owners. 

It’s important to note that states are responsible for regulating LLCs. What follows here is a high-level overview of the LLC entity model. Regulations in your state may differ, and we encourage you to reach out to our tax professionals to explore whether an LLC is the best approach for your business. 

This article is part of our series on entity selection. View our other articles here:

• The Importance of Entity Choice
• An Overview of the Sole Proprietorship Entity Structure
• An Overview of C Corporations: Tax and Non-Tax Considerations
• S Corporations: Key Tax and Non-Tax Considerations for Entrepreneurs

LLCs 101: What Entrepreneurs Need to Know

LLCs are an entity structure regulated at the state level. While requirements differ from state to state, LLCs are generally relatively easy to establish. Business owners, who are known as members of the LLC, must file with their Secretary of State (or equivalent) and pay a small fee to establish their LLC. 

This filing includes the LLC’s Articles of Organization: a document that establishes the duties of the members of the LLC. Filings also include the names and addresses of each member as well as the stated purpose of the business. Additional filings must be submitted to the IRS to obtain an Employee Identification Number (EIN). 

LLCs are particularly popular among small to midsize businesses but can be useful for businesses of all sizes. They provide personal liability protections for their owners, while also allowing for pass-through tax treatment, which can be favorable in many instances. Given this, LLCs are often described as a blend of a partnership and a corporation, offering the best of both worlds. However, as we’ll explore below, there are some limitations to the LLC model.  

Tax Considerations of Using an LLC for Your Business

Depending on the number of owners, an LLC by default is treated as a disregarded entity if there is only one owner and a partnership if there are two or more owners. If the LLC has only one owner, the income is taxed by the owner and reported directly on the owner’s tax return. If the LLC has more than one owner then a separate partnership return is required. This partnership return will generate a K-1 that reflects each owner’s flow-through income, which is then taxed on their respective tax returns. This allows business owners to avoid the double layer of taxation that corporations face, instead paying taxes only once, at their applicable income tax rate. 

While this approach is beneficial to many business owners, for others, electing to be taxed as a corporation may result in preferable tax treatment. An LLC can elect to be taxed as a corporation by filing IRS Form 8832 and can choose whether they would like to be taxed as a C corporation or an S corporation. This flexibility allows entrepreneurs to elect to the most efficient tax status for their situation. 

If you plan to structure your business as an LLC, it’s important to consider your long-term objectives – particularly if you plan to sell the business. Income from the sale of an LLC is typically taxed as a long-term capital gain, although there are some complicating factors depending on the makeup of the LLC. Further, gains from the sale of an LLC are typically not eligible for the Qualified Small Business Stock deduction. 

Non-Tax Considerations of Using an LLC for Your Business

We’ve already touched on the most attractive non-tax benefit of structuring your business as an LLC: the liability protections. When a business is structured as an LLC, owners have no personal responsibility for the business’s debts unless the owners have personally guaranteed the debts of the business.

Beyond this, there are also a series of administrative benefits to the LLC structure. An LLC can have an unlimited number of members of any form (individuals, other business entities, and even international owners). That’s in comparison to an S corporation, which may only have 100 shareholders, all of which must be individual US taxpayers or certain types of trusts or tax-exempt organizations. 

LLCs are not bound by the same record-keeping and governance requirements as C corporations. However, unlike sole proprietorships or partnerships, there are costs to establish an LLC, and in some states, annual franchise taxes must be paid. 

While an LLC offers great flexibility, it is not the best solution for every business. Certain types of businesses, including banks and insurance companies, are not allowed to be organized as LLCs. Unlike C corporations, LLCs cannot issue stock, which may dissuade potential investors. 

In many states, businesses engaged in a licensed profession, such as doctors, attorneys, and architects, must register as a Professional Limited Liability Company (PLLC). This is a similar entity structure to an LLC but typically does not offer members personal liability protections against professional malpractice claims.  

Smith + Howard: An Experienced Tax Team

Establishing your business as an LLC is a move that makes sense for many business owners. 

The setup process is relatively simple and the entity itself provides personal liability protections. From a tax perspective, an LLC offers greater flexibility, giving you the freedom to work with tax planning professionals to determine whether it makes sense for your business to be taxed as a flow-through entity, or as a C or S corporation. 

However, there are some drawbacks that business owners must be aware of. With the right approach, these can be mitigated, and it is possible to convert your LLC into a corporation through a statutory conversion or statutory merger. 

If you’d like to explore the most appropriate entity structure for your business, Smith + Howard is here to help. Our entity selection professionals work diligently with entrepreneurs and business owners to determine which entity structure is the most appropriate for their unique situation, analyzing various tax and non-tax factors to help businesses plot the best path forward. 

To learn more about how Smith + Howard can support your business’s entity selection process, contact an advisor today.