Advantages and Disadvantages of LLCs

A limited liability company (LLC) is a popular entity choice for many business owners. You can form an LLC by yourself or with other owners. Let's look at a quick summary of the pros and cons of forming an LLC.

Advantages of Forming an LLC

Fewer corporate formalities. Corporations must hold regular meetings of the board of directors and shareholders, keep written corporate minutes, and file annual reports with the state. On the other hand, the members and managers of an LLC need not hold regular meetings, which reduces complications and paperwork.

No ownership restrictions. S-corporations can't have more than 100 stockholders, and each stockholder must be a natural person who's a resident or citizen of the United States. There are no such restrictions placed on an LLC.

Ability to place membership interests in a living trust. Members of an LLC are free to place their membership interests in a living trust. It's more difficult to place shares of a corporation into a living trust.

Ability to deduct losses. Members who are active participants in the business of an LLC are able to deduct its operating losses against the member's regular income to the extent permitted by law. Shareholders of an S-corporation are also able to deduct operating losses to some extent, but shareholders of a C-corporation are not.

Tax flexibility. By default, LLCs are treated as a "pass-through" entity for tax purposes, much like a sole proprietorship or partnership. This means that LLCs avoid double taxation. However, an LLC can also elect to be treated like a corporation for tax purposes, whether as a C-corporation or an S-corporation.

Disadvantages of Forming an LLC

Profits are subject to Social Security and Medicare taxes. In some circumstances, owners of an LLC might end up paying more taxes than owners of a corporation. Salaries and profits of an LLC are subject to self-employment taxes, consisting of the federal Social Security and Medicare taxes. As of 2023, these taxes are equal to a combined 15.3%. With a corporation, only salaries (and not profits) are subject to such taxes.

Owners must immediately recognize profits. A C-corporation doesn't have to immediately distribute its profits to its shareholders as a dividend. So, shareholders in a C-corporation aren't always taxed on the corporation's profits. Because an LLC isn't subject to double taxation and the income passes through to the owners, the LLC's profits are automatically included in a member's income.

Fewer fringe benefits. Employees of an LLC who receive fringe benefits—such as group insurance, medical reimbursement plans, medical insurance, and parking—must treat these benefits as taxable income. The same is true for employees who own more than 2% of an S-corporation. However, employees of a C-corporation who receive fringe benefits don't have to report these benefits as taxable income.