Are you starting a business?
If so, then you’re probably getting all kinds of unsolicited advice.
And you’ve almost certainly been told that “You have to form an LLC.”
But, contrary to general opinion, not every business needs to form an LLC.
In most states, forming an LLC is easy and inexpensive.
Simply file some paperwork with the state, pay a one-time filing fee (usually $50 to $200), and your LLC is up and running.
Here in Massachusetts, things are never that simple.
Instead you’ll need to file your certificate of organization with the Secretary of the Commonwealth and pay a start-up fee of $500.
Each year after that, you’ll need to pay an additional $500 fee known as an “annual reporting fee.”
This certainly won’t be the largest expense you pay as a business owner.
But why give the government more money than you already have to?
How an LLC Works
To know if an LLC is right for your business, you first need to understand how LLCs work.
An LLC protects your personal assets (e.g., your house, your personal bank account, etc.) in two ways.
First, it will protect your personal assets if an LLC member or employee, other than you, behaves negligently and injures someone.
For instance, say you own a landscaping business.
One of your employees, while driving the company’s truck, runs a red light and causes an accident.
In that scenario only the LLC’s assets would be at stake if the company were sued.
Your private property would be off limits.
However, say that you were the one driving the truck.
You ran the red light and caused the accident.
In that case, both your assets and the company’s assets would be subject to any court judgment that resulted from the crash.
Second, in some cases, an LLC can protect your private property from creditors.
If you incur a debt in only the LLC’s name, then only the LLC’s assets can be seized or made subject to liens if the LLC defaults on the debt.
Unfortunately, the vast majority of creditors negate this advantage by having you sign a “personal guaranty” in order to receive their loan.
This means that both the LLC and you personally are taking responsibility for paying the money back.
Thus, if you default, both your business and personal assets could be lost.
There is one last advantage to forming an LLC.
You have the option of filing a corporate tax return.
This means that at least a portion of your profits could be taxed at a much lower rate.
Here’s an (overly simplified) example.
You form a sole-member LLC.
The LLC earns $300,000 a year.
You need only $100,000 to live and pay your personal bills.
You could file an income tax return for that $100,000.
Then file a corporate tax return for the remaining $200,000 and have it taxed at a much lower rate.
There is one caveat, however.
You will need to treat yourself as an employee of the LLC.
This means that you will need to pay payroll taxes and all other expenses associated with having an employee.
So Who Needs an LLC?
Now that you know how an LLC works, it’s easy to see who can benefit from forming one.
Employers and Business Partners
If you’re hiring employees or working with business partners, it makes sense to form an LLC.
Like I said, if they hurt someone on company time, your personal assets would likely be protected if the injury caused a lawsuit.
On the other hand, if you’re operating a single-member business, then this isn’t an issue.
Your negligence would put both your business and personal assets at risk.
Financially Successful Businesses
If your business is making more money than you need for personal income, then you could also benefit from an LLC.
Speak with an accountant and see if it’s worth it to file a corporate tax return and potentially reduce the burden of paying a hefty personal income tax each year.
Businesses Incurring Debt
Finally, if you anticipate incurring a lot of debt, then you should consider forming an LLC.
Again, most creditors will demand that you personally agree to pay them back.
Nevertheless, there are some private lenders, landlords, and other easy-going business people who will not require a personal guaranty.
Therefore, having an LLC may be to your advantage.