Although most people understand the vast benefits of limited liability companies (LLCs), significantly less are aware of the disadvantages of forming an LLC. And while the benefits may outweigh the costs, it's only fair to look at both sides of the coin and explore the disadvantages of forming an LLC. Continue reading to learn more about some of the most common disadvantages of forming an LLC.
Costs Are Disadvantages of Forming an LLC
LLCs are designed to protect business owners as individuals – but they aren't exactly designed to help them save money.
Upfront and Recurring Costs
Typically, an LLC is more costly to operate than a partnership or a sole proprietorship. Start-up fees are higher, for one thing. There are more hoops to jump through, and each hoop costs you money.
Banking as an LLC can also cost more. Some banks have higher fees or hidden costs for businesses that are incorporated. What's more, checks made to an LLC cannot be cashed; they must be deposited into a corporate account.
Taxes and Government Fees
Taxes are also typically not only more complex, they tend to be somewhat higher. Depending on the current administration and tax code, LLCs may be subject to self-employment taxes. This means the LLC's profits don't get taxed at the corporate level, they get passed through to the individuals' personal income taxes, and often these are higher than they would be at the corporate level.
LLC owners are required to pay unemployment compensation for themselves, which they would avoid if they had set up the business as a sole proprietorship. Additionally, individual LLC owners and partners must also pay for federal items like Medicare and Social Security.
Each LLC must also pay annual fees and make periodic filings with the state as well. This can vary from state to state, and some states carry higher annual fees than others.
Disadvantages of Forming an LLC Include Uncertainty
LLCs also can be burdensome in terms of predictability and control. You'll need to brush up on local rules or partner with an experienced accountant to help you sort out the different treatments based on your local laws.
And because of the liability protection that draws owners to form as an LLC in the first place, certain business types can't incorporate as an LLC at all. Laws inherent to their industry prevent them from operating under this type of organizational structure, especially when financials are involved in the service of the business. Or worse, there may be laws that allow LLC status but dictate other unplanned aspects within the business.
Confusion About Roles
Corporations have very specific roles within the organization. LLCs, on the other hand, typically do not. With no clear identification of roles, it's difficult for investors to know who's in charge of certain aspects or who can sign certain contracts and so on.
It can also be difficult for the company to know who's in charge, which can lead to disastrous chaos in a very short time. Creating an LLC Operating Agreement and defining individual roles helps resolve this issue — but that adds another up-front cost.
Record Separation and Tracking
Owners of an LLC must be careful to maintain distance. Personal business must be kept separate from the LLC's business. Any LLC should retain logically organized copies of all its own records, should keep minutes of all meetings, and generally be well on top of its paperwork.
Money must absolutely be kept separate. The pass-through on taxes must be clear and easy to follow. Businesses should maintain separate records, and an LLC's structure tends to make it more difficult to do so.
Limited Lifespan
In some states, if a member leaves the LLC for any reason (due to death, dissolution of a relationship, etc.) the LLC automatically ceases to exist. This is different from a corporation, whose identity is unaffected by the comings and goings of shareholders (again, because of clearly identified roles).
Contact Dennehy CPA for Expert Advice on Forming An LLC
Should you form an LLC or an S-Corp? What about a sole proprietorship or a partnership? We get it — choosing the best entity can be confusing. However, you don't have to do it alone. The experts at Dennehy CPA are here to help.
Contact us today for expert advice on forming an LLC or choosing the best business entity.