Operating a business as a limited liability company, or “LLC” is very popular among small business owners. LLC’s have been around for several decades and can be formed in every state. There can be several benefits, but several major drawbacks.
The Benefits of an LLC:
Less Administrative Burden: If you operate as a single-member LLC, you generally do not have to file a separate tax return. You also may not need to have worker’s compensation insurance, which can save on expenses.
Liability Protection: By having your business operate as an LLC, you will separate your business liabilities from your personal assets, which can offer protection of your personal assets.
Now, for the Drawbacks:
No Tax Withholdings: Since you usually do not draw a paycheck as an LLC member, you will not have taxes withheld from a steady paycheck. This requires you to remit estimated taxes quarterly, but in reality, many business owners miss some payments, make partial payments, or skip them altogether. This is how tax problems develop.
High Potential Audit Risk: Many LLC’s only have one owner and do not have to file a separate income tax return for the LLC. Rather, the activities from the LLC are reflected on Schedule C of their individual tax return. This is easier than having to file a corporate return, but at the same time, it increases your chances of being audited significantly.
Self-Employment Tax Shock: Since you usually have to pay self-employment tax as an active member of an LLC, this can double the amount of social security and medicare taxes because you have to pay both the employee and employer portion.
You need to carefully structure the way you operate your LLC in a manner so that you can reap the benefits, while at the same time reduce any downside. This should be performed with the assistance of a tax advisor that is well-versed in business structures.