To Form or Not to Form an LLC...
Updated: Feb 7
As a tax advisor I often get asked by my clients about a proper business structure for their new or existing businesses. Unfortunately, some ask these questions only after they had already formed their businesses as LLCs, one of the most popular form of business structures for small businesses.
LLCs are touted as easy to form and to maintain business structures yet providing necessary legal protections for their owners. Some business owners form them online with little or no help from attorneys relying instead on boiler plates from some online resources (nothing wrong with doing so as long as one has full disclosure and knows this is the best decision for one’s business!).
As with anything else in life, there is no one-size-fits-all business structure. I prefer to start a conversation with a type of business/industry you are in and with what you are trying to achieve with a specific business structure (i.e. tax, legal, combination of both, prestige). Depending on the type of the business you are in, we can determine together your general risk exposure to lawsuits for which you are seeking legal protections (for more specific questions in this area I would refer you to an attorney). Whether you have employees/co-owners in your business is another factor to consider in determining the risk exposure.
What is important to know is that legal protections of LLCs may not extend to certain activities of your business. Some actions are specific to you as the owner leaving you personally liable (for example, not depositing payroll taxes withheld from employees’ wages or personal negligence resulting in harming someone during the course of the business) and some are specific to the business (i.e. creditor debts). Depending on the nature of your business and its risk exposure, the LLC structure’s legal protections may render themselves useless to you, be just the right type and/or require additional insurance coverage to protect yourself individually (i.e. umbrella insurance) and the business.
The stage at which your business is and revenues it is making and/or expecting to make in the first few years are other important factors to consider. For example, CA LLCs require $800 annual minimum tax regardless of the amount of net income generated by your business. Once the business generates gross income in CA in excess of $250,000 (valid as of the time of this post), there is an additional LLC fee which is capped at $11,790 for gross income in excess of $5,000,000.
From a tax compliance point of view, even a single-member LLC (often disregarded for federal tax purposes) is required to file a tax return with the CA FTB which adds to the overall cost of operating an LLC. As for tax savings, LLCs for small businesses do not normally provide any particular tax advantages.
The bottom line is I would recommend running through a cost-benefit analysis to determine if it is worth pursuing this structure for your business given all the above factors and talking to your trusted advisor about the issues specific for your business in order to choose the most appropriate business structure.