LLCs are one of the most popular business structures, and their increasing popularity has led to speculation about how they work. Along with speculation, there are many prevalent misconceptions.
Entrepreneurs love LLCs, and they are an excellent middle ground between the formalities associated with running a corporation and the flexibility that general partnerships and sole proprietorships offer.
You can form an LLC by yourself, using state business resources, or you can hire an LLC formation service. No matter how you intend to form your LLC, you should protect yourself against misconceptions about the LLC. Let’s walk through the most common misconceptions about forming an LLC.
Forming an LLC
The formation process may seem more complicated than it is; to form an LLC, you’ll usually need to complete a few key steps.
These include filing a document called the Articles of Organization. The Articles of Organization vary by state but usually require the business’s physical location, the identities of all LLC members, and the registered agent’s details. You’ll also need to ensure that your business name is available and isn’t in use. You’ll need to pay a state filing fee which varies by state. Business formation isn’t highly complex.
LLC taxation is actually very simple, though some will make it seem complex. You’ll usually only be taxed once.
Whether you form a single-member LLC or have several members, the IRS will pass through income, meaning that you won’t owe corporate income taxes (the exception to this rule is if you register your startup as an S-corp). Income that is ‘‘passed through’’ will be managed via your personal tax returns with little hassle.
Avoiding taxes by forming an LLC out-of-state
It may seem tempting to form an LLC in a state that’s regarded as a tax haven, such as Nevada or Delaware, but there are some key considerations.
If you form your business in one state and operate it in another, you may still be liable to pay taxes in your state of operation/home state. For example, if you and your company are located in New York, and that’s where you conduct business, it doesn’t matter if you formed your business in Nevada ― you will still be responsible for taxes on your New York-based transactions.
You’ll also need to complete a foreign LLC registration in your own state, which could increase your fees and compliance responsibilities. You should get professional legal advice before you form an LLC out of state.
Home businesses don’t need to register
Entrepreneurs are often under the impression that they don’t need to form a limited liability company (or other formal registration) because they’re operating from home with no employees. But that’s not quite true.
Sole proprietorships do work, but there are some downsides. One of the significant benefits to the LLC is limited liability protection. This liability protection means that you’re not personally liable for any judgments against your business. If you form a sole proprietorship, you have more liability which puts your car, savings, home, etc., at risk.
Whether you have a home-based business, employees, etc., starting an LLC is wise.
Publicly trading LLCs
Most business owners know that corporations can be publicly traded, but it’s a misconception that LLCs can’t be. Since you can decide how you want to be taxed, you can choose to structure your LLC as a partnership and trade ownership shares on a securities exchange. While this is a more difficult route, you can still trade publicly. You can also elect to be taxed as an S-corporation. You would market your organization as a partnership rather than an LLC, but you’d still have asset protection afforded as an LLC. There are some additional rules and regulations, so you should consider this route carefully.
You must be a US citizen (or resident)
You don’t need to be an American citizen to own or operate an LLC. You don’t even need to live in the US. There are differences, though. The major distinction is taxation. Non-citizens don’t have Social Security numbers, so they must acquire taxpayer identification numbers (TIN) to lawfully pay taxes on their earned LLC income. The TIN is like an SSN for your business, and it automatically identifies the business owner on any necessary documentation. Apart from that, there are no significant differences. LLC ownership is identical regardless.
You don’t need insurance
LLCs offer a variety of asset protections (though this may not be as watertight as you’d hope), but they don’t replace liability insurance. LLCs won’t protect you from personal liability if you behave negligently, damage business property, etc. You should still ensure you have relevant insurance policies for personal liability, business equipment, etc.
Only small businesses use LLCs
There are plenty of ways to dispel this myth, and the easiest way is to just look at some of the largest companies in the world. Amazon owns several LLCs under a corporate umbrella.
One of the largest companies in the US (Cargill), with over 115 billion in revenue per year, is a registered LLC. Amazon is a corporation but reduces its total tax liability and decreases legal liability by owning several LLCs. If one of their subsidiary LLCs faces a lawsuit, the parent company is safe.
Personal Asset Protection
One of the most dangerous misconceptions about LLCs is about limited liability protection. The LLC’s limited protection, also known as the “corporate veil,” is excellent – but it’s not without limit. Certain situations may cause a court to circumvent it, which leaves your personal assets open to creditors. Several circumstances can lead to this unfortunate eventuality; generally speaking, your LLCs corporate veil is compromised if:
- Your LLC is being operated as an extension of you rather than a clearly separate entity
- The LLC has been used fraudulently
- Creditors have suffered unjust damage at the hands of your LLC
You can lose your limited liability protection if a court can prove these things. If you lose your liability protection, creditors may be able to pursue your personal assets such as bank accounts, car, or home.
Though LLCs are one of the most popular business structures in America, there are still plenty of misconceptions. You should avoid falling prey to them. You could end up in hot water if you don’t recognize the limitations of the corporate veil. You could also be talked into a more complex set-up if you’re unaware that smaller and larger businesses can benefit from the LLC structure. You might’ve heard one or more of the myths on this list; remember that millions of Americans have benefited from this flexible business structure for a reason.