What Is An LLC?
A Limited Liability Company (LLC) is a business organization structure used by many start-up businesses. The Michigan Limited Liability Company Act (MCL 450.4101 et seq) defines an LLC as an unincorporated membership organization.
“Limited liability” means that the members of the business are protected from personal liability for the actions of the company. If a contractor sues the LLC for breach of contract or a patron for personal injury due to a slip and fall, that person is suing the company, not its members. Unless the person can show corporate wrongdoing by a member, only the company’s assets will be at risk to pay for any judgment. Creditors are also prevented from pursuing an LLC’s members for the start-up’s debts unless they personally guaranteed the loan.
LLCs And Taxes
Both LLCs and S-Corporations are pass-through entities for tax purposes. This means that the owner of a start-up business created as an LLC will only have to file a personal tax return. He or she is entitled to business-related deductions and tax credits. It avoids the double taxation that often occurs with larger C-corporation businesses.
However, an LLC start-up owner is also considered self-employed by the IRS. This means that an owner will have to pay both the employee and employer portions of the self-employment tax. Owners of S-corporations may shift part of this tax into the entity itself.
LLC Operating Agreement Sets The Rules
An LLC gives start-up business owners the flexibility to decide what form will be most beneficial for their company. The LLC operating agreement allows partners or members to select how their business will function. This could include the free transferability of interests or a buy-sell arrangement. It may have centralized management or be owner-operated. The business could be operated by its members or through centralized officers.
The Michigan LLCA allows start-up business owners to adopt as many corporate characteristics as they want and still take advantage of the pass-through tax treatment. However, many of these characteristics can bog down a start-up business and may make it more difficult for a fledgling company to succeed.
Limitations Of The LLC For A Start-Up Business
LLCs are a popular formation model for start-up businesses, but they aren’t always the best choice. As described above, LLC members will have to pay self-employment tax. There may also be other tax consequences for a pass-through entity that could be avoided with a C-corporation.
An LLC may also limit a members’ options for investment and diversification in the long run. If the LLC will seek investors or be publicly traded in the future, it may require the business to be reorganized, which can be a costly and frustrating process. Where a company is formed can also be important to certain industries. If a start-up business would benefit from the extensive business law history of Delaware, or the tech-savy legal climate in California, it may be better to incorporate in that state, rather than operating as a Michigan LLC.
There is no one right answer to the best corporate structure for a start-up business. What you want to do with your company, and how you will pay for it, may affect your choice to incorporate or form an LLC. Entrepreneurs are well-advised to include both an accountant and a business attorney in their start-up advisory team to make certain the choices included in the formation and drafting of an operating agreement will be beneficial to the company.
The Cronin Law Firm has experienced attorneys to aid with whatever legal issue you’re facing. If you considering founding a start-up business, contact The Cronin Law Firm today to schedule a consultation.