Stuck wondering, “Do I Need an LLC?”. Well, we can help you pick what’s best for your business and more than likely you probably don’t need one, at first.
I have a significant number of friends and family who are unsure about whether they need an LLC.
Also, a lot of the articles I’m finding online start from the point of either already having an LLC or, having formed one, asking how to use it.
Every single one of those posts is putting the cart before the horse.
You don’t need an LLC. Not yet, anyway.
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What is an LLC?
Let’s talk about what an LLC actually is, and what it does.
An LLC is a contract between you, the state you form it in, and zero or more other members.
At its core, an LLC is documentation of an agreement between some people on how to run a business.
What liabilities does an LLC actually limit?
The word company in a limited liability company is pretty easy to understand, but the other two words are what trip lots of people up.
An LLC protects you from the financial liability incurred by the company.
A very simple example: let’s say your LLC buys some product worth $300 and the vendor allows you to pay on Net 30 terms (i.e. payment is due 30 days from the day the product leaves their warehouse).
Your LLC is effectively in debt to the vendor. If you shut the business down within those 30 days, the vendor can sue your business for the amount you owe them, but (barring extenuating circumstances) they can’t sue you personally.
If the business has no cash to pay them back, they take the loss.
So that means I can take out loans in the name of the business and just not pay them back?
No. Of course not. Banks and vendors are never going to give your brand new business credit without a personal guarantee.
A personal guarantee is a contract that says, in the event, the business can’t pay the debt you personally will pay it. It’s exactly like cosigning a loan with someone.
What about taxes? I’ve heard an LLC will let me deduct expenses.
By default, a single-member LLC is what the IRS refers to as a disregarded entity. That means they don’t care about it. As the owner, the income passes through to you individually via your personal form 1040 on Schedule C and Schedule SE.
Schedule C and SE are the exact same forms that a sole proprietor uses and they let you deduct any ordinary and necessary business expenses. Nothing about an LLC gives you any tax advantage over just operating as a sole proprietorship.
There’s a small exception to that (because there always is). If you make more than about $100k in profit it may be beneficial to form an LLC and elect S-corp taxation status. That means that, instead of ignoring your business, the IRS treats it as a small business corporation.
The upshot of that is that you get to control how much profit is subject to self-employment taxes. The downside is that you have to spend money on tax preparation (the forms are not a DIY project), and you have to pay a payroll company to run payroll for you. If you already have employees this is no big deal, but if you’re the only employee it can be a significant expense.
Also, keep in mind that some states have minimum franchise taxes. California, in particular, is very aggressive about this. If your LLC has a tax nexus in California you will owe them at least $800 per year in franchise tax even if your business does nothing or takes a net loss. You don’t have to pay this for a sole proprietorship
What states have minimum franchise taxes?
The states that currently have franchise taxes are: Alabama, Arkansas, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, New York, North Carolina, Oklahoma, Pennsylvania, Tennessee, Texas, and West Virginia.
When do I definitely need an LLC?
There are a few circumstances when an LLC is definitely beneficial.
When your business will have multiple owners. Remember what we said above: an LLC is an agreement on how to run a business. When it’s just you, you don’t need a binding piece of paper to document how you want to do things. When there are multiple people involved it’s almost always better to have everything written down when you’re happy with each other.
When you make more than $100k in profit. See the previous section about electing S-corp taxation and talk to an accountant about how this maybe can save you money (stash this money in an emergency fund), but keep in mind their fees.
When your business is legal but maybe not completely socially acceptable. For example, if you are a porn producer or something and don’t want your neighbors to be able to easily associate it with your name an LLC can provide a useful anonymity shield. It won’t be completely anonymous, of course, but it’ll protect you in cursory background checks.
There are other more esoteric uses for LLCs (estate planning, shell companies, etc) but they’re outside the realm of this article.
What should I do instead, hotshot?
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Make money first, then spend a little bit of it to talk to an accountant and an attorney about how forming an LLC or other entity can help you. Don’t do it lightly, and definitely, don’t do it before actually earning some revenue with your online business ideas.
Regardless of whether you end up forming an entity, buy business insurance. Good professional liability and general liability policies are absolutely worth the price and will actually cover you for torts and contract disputes. Do your research and work with an agent to figure out how much and which coverages you need. If your business requires you or employees to drive while on company time, make sure you carry business automotive insurance as well. Personal policies almost never cover accidents that happen while working.
Bottom line: Is that you don’t necessarily need an LLC right away before you actually have a fully formed business idea, with some wallet out customers, ideally people who have already paid you for something related. If you have that, great! Talk with an attorney and an accountant and get your ducks in a row. If you don’t have that, work on getting to that point before worrying about formal structure.
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