Three Reasons to Form a Limited Liability Company

Want to limit your business liability? While many business owners choose to form a regular corporation, a limited liability company often makes more sense for three important reasons.

Reason #1: Really Easy Setup

Most states let you form a limited liability company simply by downloading and then filling out a simple one or two page form.

In other words, with an LLC, you often don't need an attorney or accountant to help with preparation of the formation documents. And with an LLC you typically don't need to complete incorporation tasks such as having an organizational meeting, electing a board of directors, having a board meeting to elect corporate officers, and so forth.

Reason #2: Better Liability Protection

Some people wonder if limited liability companies offer protection as good as a regular corporation. But quite possibly, a limited liability company offers you better protection than a regular corporation-and for two big reasons.

The first factor that explains the better liability protection of a limited liability company concerns the LLC's simpler operation. A limited liability company should be easier to operate which means you're less likely to inadvertently weaken the liability protection by making some mistake or forgetting to take care of some corporate task.

For example, with a corporation, you might get sloppy and not have regular shareholder meetings or board of directors meetings. These sorts of omissions could weaken the liability protection of the corporation.

With a limited liability company, you often don't need to have shareholder meetings or a board of directors-which you can't screw up these items.

A second factor, the use of charging orders, can also mean that a limited liability company offers better asset protection. But let me explain. If you own shares in a regular corporation, your personal creditors may in a worst-case scenario be able to gain ownership of your shares of stock for something that happens outside the corporation.

For example, if you get sued because some young child gets hurt in your home's backyard, you might lose assets you own like your home and the shares in your small business corporation.

With a limited liability company, however, many states say a personal creditor can only grab your share of the distributions the limited liability company makes to owners. (This is the actual charging order.)

In other words, in many states, even in a worst-case scenario, you might not lose control or ownership of a limited liability company. The worst-case scenario might be that should you decide to make a distribution to owners, you would have to give the money to the personal creditor with the charging order.

Obviously, a charging order leaves an LLC owner tremendous leverage in negotiating with personal creditors even in a worst-case scenario.

Reason #3: Total Tax Flexibility

A third big reason to consider using a limited liability company concerns income taxation of the business. In a nutshell, a limited liability company gets to choose how it wants to be treated for income purposes.

A one owner LLC (called a single member limited liability company) by default gets treated as a sole proprietorship. But the single member LLC can often make an election to be taxed as an S corporation or as a regular C corporation.

A multiple owner LLC (called a multiple member limited liability company) by default gets treated as a partnership.

But, again, the multiple member LLC can often make an election to be taxed as an S corporation or regular Corporation.

Note: The entity is still a limited liability company for state law purposes. However, for federal and usually state tax purposes, the entity can be considered an S or C corporation after making the tax elections.

The tax flexibility afforded by a limited liability company often means a business owner can keep his or her accounting really simple in the early years of operation. And of course, that saves money and time.

In later years, after the firm establishes itself, the LLC for tax purposes can morph into an S or C corporation if a corporation saves the business or the owner taxes.