Taxes Made Simple

Almost everything you read today about the different legal structures for your business seems to indicate that forming a Limited Liability Company (LLC) is usually the way to go. Before going and getting your Articles of Organization ready, I’d recommend giving it a second thought. Depending upon your business and your location, you may find out it’s a waste of time and money.

But I’ll Gain Limited Liability, Right?

One of the largest supposed benefits of forming an LLC is that you will gain limited liability. The general idea is that, if somebody successfully sues your business as a result of injury caused by your product or services, he will only be able to get access to the business’s assets, not your personal assets. The other benefit of limited liability is that if your business has to take on debt, and then your business goes bankrupt, you won’t be personally liable for the debt.

However, there is one extremely important, often-overlooked exception. If a lawsuit arises as a result of services that you performed personally (as opposed to an employee performing the service), your supposed protection no longer applies. Courts have ruled repeatedly that the plaintiff will be able to hold you personally liable for services you performed, even if they were performed in the name of your LLC.

It gets worse. When your business is new, if you want to take out a business loan, you will probably have to personally guarantee the loan in order to get your bank’s approval. As such, your limited liability isn’t going to help you here either.

Tax Benefits?

Another frequently mentioned benefit of forming an LLC is that they offer a very simple tax situation. Generally, this is true. For Federal income tax purposes, LLCs are “disregarded entities.” This means that the IRS will make no distinction between the LLC and its owner(s). As such, if you’re the only owner, your LLC will be taxed as if it were a sole proprietorship (the simplest tax situation for a business).

However, some states don’t treat LLCs the same way that the Federal government does. For instance, in California and Illinois, LLCs are subject to an entity level tax. This double taxation is similar to the way corporations are taxed, with the business being taxed on its profits, and the owners being taxed when the profits are paid out to them. In other words, if your LLC is in Illinois, you will be running a sole proprietorship as far as Federal income taxes are concerned, and a corporation-like business as far as your state income tax is concerned. How’s that sound for confusing?

So What Now?

Please don’t think that I’m saying that forming an LLC is a bad decision. It might very well be the best way to go (particularly if you have employees and want to be protected in the event that one of them makes a lawsuit-triggering mistake). Just make sure you thoroughly research the LLC, S-Corp, or C-Corp decision, and do a little thinking on your own before blindly accepting the conventional wisdom.

For More Information, Take a Look at My Related Book

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A Testimonial from a reader on Amazon:

"A very concise and practical guide to the formation, taxation and legal differences between Sole Proprietorships, Corporations and everything in between. Very easily read with a simplified presentation makes this a great introduction to help you decide how to form your business." - Michael J Reed

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