Advantages and Disadvantages of an LLC
A limited liability company (LLC) is one of the most popular structures for small businesses. For many businesses, forming an LLC is the best and simplest option, but this doesn't mean that it's right for all companies.
In this article, we’ll cover the advantages and disadvantages of an LLC to help you choose the best structure for your business.
What Is an LLC?
Limited liability protects a business owner’s personal assets (e.g., car, house, and savings) in the event that a business is sued or defaults on a debt.
The main cost of forming an LLC is the state filing fee, which ranges between $40 and $500, depending on your state.
There are two options for forming an LLC:
Here are some of the biggest advantages of forming an LLC:
- Personal liability protection
- Tax flexibility
- Easy to start
- Less compliance paperwork
- Management flexibility
- Distribution flexibility
- Charging orders
Personal Liability Protection
Limited liability companies provide their owners with personal liability protection. This means the owner isn’t in danger of losing their personal assets if the LLC goes into debt or is sued. Sole proprietorships and general partnerships do not offer this protection.
Corporations offer liability protection but are generally not suited to small businesses.
It is important to note that owners can lose this protection if the LLC’s “corporate veil” is pierced. This can happen if the owner mixes their personal finance with the business’s, if they commit fraud, and in certain other circumstances.
By default, LLCs are subject to “pass-through taxation,” where the LLC's profits pass-through to each owner's individual tax return and are taxed at the owner’s personal tax rate. The LLC does not have to pay any federal corporate income tax, meaning that the owners can avoid double taxation of a corporation while still having the benefit of liability protection.
Easy to Start
Compared to C corps and S corps, LLCs are quite easy to start. You generally don’t need an attorney to form an LLC, and you can file the paperwork yourself for between about $50 and $500, depending on the state.
To learn how easy it is to start an LLC yourself, select your state:
- Alabama LLC
- Alaska LLC
- Arizona LLC
- Arkansas LLC
- California LLC
- Colorado LLC
- Connecticut LLC
- Delaware LLC
- Florida LLC
- Georgia LLC
- Hawaii LLC
- Idaho LLC
- Illinois LLC
- Indiana LLC
- Iowa LLC
- Kansas LLC
- Kentucky LLC
- Louisiana LLC
- Maine LLC
- Maryland LLC
- Massachusetts LLC
- Michigan LLC
- Minnesota LLC
- Mississippi LLC
- Missouri LLC
- Montana LLC
- Nebraska LLC
- Nevada LLC
- New Hampshire LLC
- New Jersey LLC
- New Mexico LLC
- New York LLC
- North Carolina LLC
- North Dakota LLC
- Ohio LLC
- Oklahoma LLC
- Oregon LLC
- Pennsylvania LLC
- Rhode Island LLC
- South Carolina LLC
- South Dakota LLC
- Tennessee LLC
- Texas LLC
- Utah LLC
- Vermont LLC
- Virginia LLC
- Washington LLC
- Washington D.C. LLC
- West Virginia LLC
- Wisconsin LLC
- Wyoming LLC
Less Compliance and Regulatory Paperwork
LLCs also have a lot less paperwork to file than corporations. While many corporations are legally required to have regular board meetings, keep meeting minutes, and file other documents, LLCs can avoid most of this.
LLCs offer a couple of possible privacy advantages over sole proprietorships. For one, some states don’t require LLCs to list their members on the formation documents. You may have the option to list a manager instead of all the members.
LLCs can also take advantage of registered agent services and list the registered agent’s office as their mailing address on official documents. This can help protect your home address in instances where you aren’t permitted to use a P.O. box.
Most LLC formation services include a free year of registered agent service when you start an LLC.
Learn more in our Best Registered Agent Service review.
LLCs can choose to be either member-managed or manager-managed. In a member-managed LLC, the members are actively engaged in the operations of the company; in a manager-managed LLC, the members delegate this responsibility to a manager (this manager can be one of the members).
LLCs also aren’t required to have a board of directors, while C corps are.
LLCs have the option of distributing profits to their owners however they choose. The default method is to allocate the profits in line with each member’s ownership stake in the company, but other allocations can be outlined in the LLC’s operating agreement.
If one of the owners of an LLC has debts or must pay a judgment from a lawsuit, their creditors may go after personal assets, including ownership stake in an LLC. A charging order puts a lien on that member’s earnings from the LLC, but it protects the interests of the other members and also allows the indebted member to continue their role in the company without giving the creditor any power to run the company.
Compared to a sole proprietorship or general partnership, forming an LLC gives a business more credibility with customers and other businesses (including lenders and small business banks.
While forming an LLC is a great option for some businesses, there are some potential disadvantages of LLCs that might not make it a great fit for everyone.
Keep in mind that these disadvantages are situational and may not apply depending on an individual’s and the company’s specific circumstances:
- Investor appeal
- Members must immediately recognize profits
- State fees and taxes
- Ownership transfer
- Not an option for some businesses
Big investors typically prefer to invest in corporations over LLCs. So, if you think your company is going to need a big private equity investment down the line, a corporation might be a better option.
Members Must Immediately Recognize Profits
Corporations can hold profits at the corporate level to reinvest into the company or to distribute later as dividends. The drawback is that those profits are taxed at 21% when carried over to the next tax year.
Any profits an LLC makes must be distributed to its owners or reinvested back into the business each tax year. Most small businesses reinvest profit for many years before seeing the business growth that would warrant forming a corporation.
Learn more in our LLC vs. Corporation guide.
While LLCs are relatively inexpensive to form and maintain compared to a corporation, they are generally more expensive than informal business structures like sole proprietorships that don’t need to register.
Keep in mind, not having limited liability protection could be far more expensive in the long run than the cost to form an LLC.
State Fees and Taxes
Some states require LLCs to pay annual or semiannual fees or taxes to do business in the state. Depending on the state, these taxes can be a flat fee or based on the revenue or income of the company.
Choose your state from the list on this page to learn more about possible LLC annual report costs.
LLCs don’t have shares of stock like corporations do. This can make transferring ownership more difficult. This is potentially more challenging in multi-member LLCs when the other members need to agree on any ownership changes.
Not an Option for Some Businesses
Certain types of businesses, such as banks and insurance companies, can’t form LLCs. There are other restrictions in some states that include professional companies like law firms or doctor’s offices from forming LLCs.
However, they may have the option to form a professional limited liability company (PLLC).
Advantages and Disadvantages of an LLC Frequently Asked Questions
What are the benefits of an LLC?
Some of the benefits of an LLC include personal liability protection, tax flexibility, their easy startup process, less compliance paperwork,management flexibility, distribution flexibility, few ownership restrictions, charging orders, and the credibility they can give a business.
Learn more here: LLC Benefits guide.
What is the downside to an LLC?
The downside of an LLC is the lack of investor appeal compared to corporations, a higher cost than just having a sole proprietorship.
Learn more here: LLC Benefits guide
How do LLC owners get paid?
LLC members get paid differently depending on the LLC’s tax structure. Read our How Do I Pay Myself From My LLC article for more information.
Is an LLC better for taxes?
LLCs are better for taxes for some businesses but not for all. Read our LLC Tax Guide for more information.
Do LLCs pay more taxes than sole proprietorships?
LLCs and sole proprietorships have the same default tax structure. However, LLCs are also eligible to elect S Corp tax status, which could potentially result in them paying fewer taxes than a sole proprietorship, depending on the situation.
Learn more here: LLC vs Sole Proprietorship guide.
Do I need an LLC if I am self-employed?
You don’t need an LLC if self-employed, but we recommend forming an LLC over a sole proprietorship because of the advantages that LLCs offer.
Learn more here: LLC vs Sole Proprietorship guide.
How is an owner's draw taxed in an LLC?
An LLC owner must pay Federal Insurance Contributions Act (FICA) self-employment taxes on their owner’s draw or distribution.
Learn more here: How to Pay Yourself From an LLC guide.
How do I create an LLC?
How much does an LLC cost?
The main cost of forming an LLC is the state registration fee, which is between $40 and $500, depending on the state. If you decide to use a professional service to help with the formation, there will be added expense.
How are LLCs taxed?
Read our LLC Tax Guide for more information.
What is pass-through taxation?
Pass-through taxation is a system of taxation that generally applies to sole proprietorships, partnerships, LLCs, and S corps. In this system, the profits or losses of the business are not taxed at the business level. Instead, they pass through to the owners’ personal tax returns and are taxed at each owners’ personal income tax rate.
Read our LLC Tax guide for more information.
Where should I form an LLC?
You should form your LLC in the state where it’s located or conducts business. While certain states may have more business-friendly laws and policies, it becomes more complicated if the business is not actually located there.
Visit our Best State to Form an LLC guide to learn more.
Do I need a lawyer to form an LLC?
You typically don’t need a lawyer to form an LLC. You can easily create an LLC yourself by using our free How to Form an LLC guide, or you can use an LLC formation service to register your LLC for you.
Is it better to form an LLC or a DBA?
Your business’s unique situation and needs will determine whether it’s better to form an LLC or a DBA company. A DBA is a doing business as name and many sole proprietors choose to use a DBA name. In an LLC, you won't need a DBA because LLC formation registers your legal name with the state.
Read our DBA vs. LLC guide for more information.