Why LLCs are Popular

  • Personal Liability Protection
  • Pass-Through Tax Treatment
  • Management Flexibility
  • Ownership Not Restricted

1) Personal Liability Protection:

Like shareholders of a corporation, LLC members are not personally liable for LLC debts or obligations arising from contractual arrangements between the LLC and others.

LLC members receive the same personal liability protection as shareholders of a corporation without having to incorporate. This is an attractive feature because you save the time and expense of going through the incorporation process.

There is an exception to the limited liability protection that you should be aware of:

  • Trust fund taxes.

Trust fund taxes include:

  • Federal income taxes that should have been or were withheld form employees' gross pay and
  • The employee's share of FICA taxes which consists of social security and Medicare taxes withheld from salaries and wages.

Regardless of the legal form of business, LLC or corporation, owners may still be held personally liable for delinquent trust fund taxes. And filing bankruptcy won't help either.

Not only may each of the owners be held liable, the IRS can even look to employees of the business who had responsibility for the payroll.

2) Pass-Through Tax Treatment:

Pass-through tax treatment provides LLC members with two important tax advantages:

  • No double taxation
  • Deductible business losses

An LLC does not pay tax on income at the entity level. Therefore, LLC income is taxed only once, at the individual level.

This is in contrast to C corporations where income may be taxed twice, first at the corporate level then at the individual level when after-tax income is distributed to shareholders as a dividend.

A multiple-member LLC is automatically taxed as a partnership unless an election is made on Form 8832 to be taxed as a corporation or Form 2553 to be taxed as an S corporation.

A single-member LLC is automatically taxed as a sole proprietorship unless an election is made on to be taxed as a corporation or Form 2553 to be taxed as an S corporation.

Sole proprietorships and partnerships receive pass-through tax treatment. This means owners pay income taxes on their share of business income on their own individual income tax return and get to deduct net business losses from other sources of income reported on Form 1040.

3) Management Flexibility

An LLC is not subject to certain statutory constraints the way corporations are.

For example, C corporations must hold annual shareholder meetings and prepare minutes of meetings and retain applicable documents as evidence state laws have been complied with. LLCs do not have to meet such requirements.

LLC members may conduct business according to the rules specified in the LLC operating agreement which is created by the members and may be tailored to meet their needs.

For example, the operating agreement may specify how profits will be distributed and how ownership interests may be disposed of.

However, without an operating agreement, the LLC will default to the rules prescribed by the state of formation which are not generally as flexible as the LLCs operating agreement.

LLC members are allowed to participate in the management of the LLC without losing their personal liability protection. This is in contrast to limited liability partners in a general partnership who may lose their limited liability protection if they participate in the management.

An LLC may be member-managed or manager-managed by nonmembers. When members manage the LLC it is similar to a partnership structure. When nonmembers manage the LLC it is similar to the corporate form organization.

4) Ownership Not Restricted:

Unlike an S corporation, where ownership is restricted to a maximum of 100 shareholders, an LLC may have an unlimited number of owners (members). This may be important to some people.

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