Limited Liability Companies For Dummies
Limited Liability Companies, or LLCs, are a business entity that you can think of as a merger of the partnership and the corporation with all the good qualities of each and none of the bad. This type of business structure offers full limited-liability protection to all the owners (like the corporation), yet has pass-through tax status (like the partnership). In addition, the LLC has a second layer of liability protection that shields the business from any personal lawsuits that may befall you. Overall, the LLC offers great benefits to business owners.
The Amazing Benefits of Limited Liability Companies
LLCs, or limited liability companies, are one of the most flexible business entities. They allow you to choose how to distribute the profits, decide who manages the business’s day-to-day affairs, and decide how the profits are to be taxed. They also offer a lot in terms of liability protection. The overall advantages of the LLC include the following:
Personal liability protection: Any creditors who come knocking or lawsuits filed against your business can’t affect you personally. You can rest assured that no matter what happens in the business, your family’s assets are safe.
Business liability protection: An LLC is one of the only entities that prevents personal lawsuits and creditors from liquidating your business to satisfy a judgment.
No ownership restrictions: You can have as many owners as you need. Even other entities can be owners!
No management restrictions: Owners can manage and managers can own — you decide.
Flexible tax status: You can choose from a multitude of ways to be taxed, depending on what works best for your situation.
No separate tax returns: With a standard LLC, the business’s profits and losses are reported on your personal tax returns.
No double taxation: Unlike some business structures, LLCs can have pass-through taxation. This means that the profits won’t be taxed at the company level, only at the individual level.
Flexible profit distribution: You decide what percentage of the profits to give to whom — no matter how much of the company the person actually owns.
Giving Your Limited Liability Company a Great Name
You can’t expect to pick a great name for your LLC (Limited Liability Company) out of thin air. Creativity is best served when subject to a few helpful restrictions. The following are a few naming rules for your businesses:
Be distinct. Naming your brand-new and improved social media site FaceSpace or MyBook won’t give the impression that you are either new or improved. Quite the opposite, actually.
Be memorable. Avoid acronyms like the plague. Unless you have a huge annual marketing budget to waste, don’t attempt to grab anyone’s attention with a few letters. If you’re serious about shortening your name, condense it into an amalgam, like FedEx for Federal Express, or Nabisco for National Biscuit Company.
With that being said, contrary to what you may hear elsewhere, long names are often a lot more memorable than short names (think T.G.I. Fridays versus Joe’s). So don’t worry about restraining yourself with length — especially since you’ll have better luck finding a domain name for a longer name than a shorter one.
Be approachable. Make sure your LLC’s name is easy to pronounce. You don’t want people to avoid saying the name because they’re afraid of mispronouncing it. Try out potential names on a first grader. If he can’t pronounce it, ditch it and have him help you find an alternative. Hey, you’d be surprised at what good ideas kids can have!
Be meaningful. This doesn’t mean be descriptive; save the description for your tag lines and slogans. Make your LLC’s name evocative and allude to the heart and soul of your business. For instance, Netflix is a great name for an online video rental site, whereas FilmsOnline is not.
Be vivid. What image and feeling do you want your customers to associate with your brand? Try to paint a picture. For example, the name Stonyfield Farm makes you think of cows in green pastures, which gives the impression of wholesomeness.
Be bold. With so many names already taken, you can’t be afraid of taking risks. As long as your name is evocative, don’t worry about being too unusual — just look at Yahoo! and Google.
Be eternal. LLCs are now made to have a perpetual existence, so why restrict the life of your business with its name? Choose a name that will sound good for decades or even centuries down the road, or you may face the same conundrum as Twentieth Century Fox.
Be expansive. Be careful that your name doesn’t restrain your business to a specific location, product, or service. For instance, Los Angeles Rentals would have to spend a pretty penny on rebranding if it ever were to expand to another market. No matter how small you are now, you don’t want your name to hold you back or become antiquated as your business moves forward.
Be global. Make sure your name is internationally friendly. Otherwise, you may be ready to expand abroad one day only to find out that your name has a negative connotation in certain cultures!
Reviewing Tax Types for Limited Liability Companies
Because LLCs (limited liability companies) are allowed to elect pretty much any tax status that suits them, the federal returns, information statements, and notices that they are required to file each year vary accordingly. An LLC can choose the following types of taxation: disregarded entity, partnership, corporation, or S corporation.
Disregarded entity taxation
Disregarded entity isn’t so much an election as a default tax status for single-member LLCs. Single-member LLCs don’t qualify for partnership taxation because no partners exist, so they’re automatically subject to this form of taxation unless they elect corporation or S corporation tax status.
This form of taxation can actually be beneficial for some real estate and investment transactions. When considered a disregarded entity by the IRS, your company is treated as if it doesn’t exist and you’re taxed simply as an individual (or as a sole proprietorship, to be exact). This arrangement can be beneficial when executing tax credits, deductions, and strategies that only apply to individuals, such as mortgage interest deductions and special exception rules in a 1031 exchange of real estate.
Partnership taxation is the default tax status for limited liability companies with more than one member. It’s a form of pass-through taxation. The primary benefit of partnership taxation over other forms of pass-through taxation is that you can vary the profit and loss allocations to the partners. Additionally, recourse loans are, for the most part, deductible to the members who guarantee them.
The corporate tax status differs dramatically from all others. It’s the only non-pass-through form of taxation an LLC can elect. The revenues and expenses, and thus the profits and losses, of the company do not pass through to the members, but instead are retained in the company and taxed at the applicable corporate income tax rate. Because the corporation tax rate is generally lower than what an individual pays, this status can often be beneficial.
Additionally, when a member sells his interests in the company, the profit from that sale is subject to a very favorable long-term capital gains rate. This can result in substantial tax savings. The major drawback of corporate taxation, though, occurs when ordinary profits (called dividends) are removed by the members, causing a double-taxation scenario.
S corporation taxation
The corporation’s answer to pass-through taxation, S corporation tax status came about when small, closely held businesses (such as independent contractors) needed the ability to operate under the liability protection of a corporation but without the heavy tax and regulatory burden that comes with the standard corporation. Note that S corporation is not an entity type, but instead simply a tax election that can be made by either a corporation or an LLC.
The S corporation’s claim to fame is the members’ ability to hire themselves and pay themselves a salary. Although the resulting tax burden is ultimately equal to the income tax and self-employment tax they would pay with partnership taxation, the members only pay income tax on amounts over the salary they pay themselves, as opposed to members subject to partnership taxation who have to pay income tax and self-employment tax on all profits over their salary. Obviously, you can’t just pay yourself $1 and be done with it. The IRS stipulates that your salary must be consistent with others in your industry and your position.