A sole proprietorship is often the initial, reflexive choice for small business owners. With all the profit and power in your capable hands, why should you choose to incorporate your business?
While it may seem like more work you don’t want to do, the business structure you choose largely affects your personal liability, regulations you will have to conform to, and how you pay taxes. So, you might wield a lot of autonomy as a sole proprietor, but you’re also solely responsible for all the associated risks.
Meet Limited Liability Corporation (LLC)—the most highly endorsed business structure, particularly for small businesses. Keep reading to discover why forming an LLC is the best way to protect your personal assets and run your business.
How does an LLC work?
Although an LLC has the limited liability of a corporation, it isn’t one. An LLC is the simplest business structure that allows you to have pass-through taxes for the LLC members (as a partnership would). Simply put, an LLC formation combines the best of both worlds (corporations and partnerships or sole proprietorships).
There are several benefits of an LLC. As a legal entity, you gain the following LLC advantages.
Benefit #1: Limited liability
Through a sole proprietorship or traditional partnership, there is no distinction between personal assets and professional assets. Thus, if someone were to sue your business, then they could require you to pay your business debts with your own money, even if it means you have to declare bankruptcy or liquidate your assets to settle. And vice versa—should a personal financial crisis arrive, your business could pay.
Forming an LLC separates your business from you. This limited personal liability is a form of asset protection not granted for a sole proprietorship or a traditional partnership.
However, you must be sure to keep your personal and business finances separate. Particular practices should be avoided to guarantee limited liability protection, such as:
- Mixing Business with Pleasure – Also known as using the company’s credit card for personal expenses
- Stirring the Pot – Maintaining the LLC’s and your own funds in the same bank account
- Wolfing on Wall Street – Any fraudulent or criminal activity (obviously).
Benefit #2: structural flexibility
Unlike the established structure of a corporation, LLCs can determine what form of management and ownership works best for them. To be a single-member LLC or multi-member LLC, member-managed, or manager-managed, an LLC offers the ability to operate at your discretion.
Moreover, as opposed to corporations, limited liability corporations typically don’t require:
- Designated formal roles
- Extensive record keeping
- Yearly fees
- Yearly reports
- Yearly shareholder meetings
Meetings at a burger joint and minimal phone calls? No more suits or 7 A.M. commutes? These are the luxuries provided to LLC owners.
Quick Note: You will need to have an LLC Operating Agreement to establish the guidelines for your business, or else your company will be under the authority of state rules.
Benefit #3: pass-through taxes
LLCs do not belong to any specified federal taxation classification. Rather, the Internal Revenue System (IRS), by default, categorizes an LLC as a sole proprietorship (if there’s one owner) or a traditional partnership (if there are multiple owners). Resultantly, profits go directly to the LLC’s owners and are taxed through their individually-reported tax returns.
Therefore, the LLC profits avoid being double-dipped by the IRS. The profits are taxed once, which is referred to as pass-through taxation. Pass-through taxation allows business owners to avoid any LLC or corporate taxes.
Meanwhile, c-corporation profits are taxed before distribution to owners and then again when filing their taxes, known as double taxation.
Benefit #4: tax flexibility
In this world, nothing is certain, save for the fact that everyone loathes taxes. Yet, while LLCs lack their own tax category, they can switch their designation, which is one of the many tax advantages. LLCs have the freedom to decide whether they’d like to file with the status of a:
- Sole proprietorship
- Traditional partnership
For example, switching to an s-corp classification when your business generates enough profits can prevent self-employment taxes from draining your profits. As an s-corp, not all income is subject to a self-employment tax, including payment to shareholders in the form of dividends.
Ultimately, forming an LLC grants you options, should you wish to make use of them.
Benefit #5: profit distribution flexibility
Under an operating agreement, LLCs are not obligated to distribute profits based on the percentage of ownership or equity. For instance, several founding members with equal shares may agree that you should receive a more significant portion of the profits because you invested more initially.
Benefit #6: strengthen credibility
Generally, an LLC is viewed as a more formal business structure. Like showing up to your high school reunion with Doctor tacked onto your name, the mere addition of an LLC may lend a sense of credibility (to your business) that appeals to the following parties:
Benefit #7: access to funding
Financing business debts can be difficult as a sole proprietor. While you might be able to secure a personal loan or credit card, it tends to have a lower lending or spending limit and higher interest rates. Additionally, any racked up business debts will negatively impact your credit score and be your responsibility to pay off.
Whereas an LLC will often allow you to qualify for a higher limit since any debt would be the business’. It comforts financial institutions knowing they’re funding your business and not a proclivity for betting on turtle races. Also, with an operating agreement, equity financing becomes an option with the availability of stocks for negotiation.
Tip: Building your LLC operating business’ credit history will bolster your ability to qualify for credit lines and loans.
Benefit #8: additional business protection
While an LLC protects your assets, it doesn’t cover you from responsibility if you:
- Injure one of your employees, or someone else
- Are negligent or reckless
- Engage in an illegal activity
There is no guarantee that your status as a limited liability corporation would be sufficient to shield you in court. Consider a supplementary form of security via a business insurance policy. Not only could it support your reputation as an LLC, but it could also give you personal protection in the event of a lawsuit.
At Thimble, we offer general liability insurance and professional liability insurance that’s radically simple—it’s sold by the hour, day, or month. By adding a plan in conjunction with your LLC, you can rest easy knowing you’ve created the proper infrastructure to protect your business—helping shield you should something go awry.
Protect your business
Any industry is going to have its own set of risks. Although, unlike mega-corporations, one lawsuit has the potential to really hinder a small business. While there may be more paperwork and fees associated with shifting to an LLC, the payoff is worth it (just like getting insurance).
With a limited liability corporation, you are granted flexibility, tax benefits, and financial security—without the excessive time commitment and paperwork of a corporation. The occurrence of an incident might be an uncertainty, but asset protection when you need it doesn’t have to be. Make the switch to form an LLC today, get an insurance quote from Thimble, and safeguard your tomorrow.
Our editorial content is intended for informational purposes only and is not written by a licensed insurance agent. Terms and conditions for rate and coverage may vary by class of business and state.