Should I Start an LLC for My Software Development Business?

Starting a limited liability company (LLC) for your software development business can provide several benefits.

Most importantly, an LLC structure offers limited liability to its owners, which can protect their personal assets from lawsuits and creditors.

For a software development business, lawsuits can arise from things like breach of contract (e.g., after being unable to deliver a completed app to a customer on time) or the release of clients’ personal info in the event of a security breach.

LLCs are also affordable, highly flexible (from a tax point-of-view), and can make your software development business seem more credible.

Recommended: Use Northwest to form an LLC for $29 (plus state fees).

Do I Need an LLC for a Software Development Business?

LLCs are a simple and inexpensive way to protect your personal assets and save money on taxes.

You should start an LLC when there's any risk involved in your business and/or when your business could benefit from tax options and increased credibility.

LLC Benefits for a Software Development Business

By starting an LLC for your software development business, you can:

Protect your savings, car, and house with limited liability protection
Have more tax benefits and options
Increase your business’s credibility

Limited Liability Protection

LLCs provide limited liability protection. This means your personal assets (e.g., car, house, bank account) are protected in the event your business is sued or if it defaults on a debt.

Software development businesses will benefit from liability protection because of the risk of product liability, intellectual property claims, and financial data breaches.

Example 1: You hire a freelance software developer to create a custom app for your business. However, the developer fails to deliver on time, and you lose customers who wanted access to the app before their competitors. As a result, you are sued by one of your clients for breach of contract and financial losses. With limited liability protection in place, only your business assets will be at risk, protecting your personal assets from any potential legal damages.

Example 2: You store customer data and intellectual property on your company servers. A security breach occurs due to a software malfunction, jeopardizing the safety of this information. As a result, you may be held liable for any financial losses or legal penalties incurred by affected customers as a result of the data breach. With limited liability protection, your personal assets will be protected from any such costs or penalties.

Example 3: You work with a team of software developers to build new applications or update existing software. During this process, one of your employees makes an error and slows down the development timeline. As a result, you miss critical deadlines and lose business to competitors. With limited liability protection in place, you can rest assured that your personal assets will be protected if you are sued for damages.

An LLC will also protect your personal assets in the event of commercial bankruptcy or loan default.

To maintain your LLC's limited liability protection, you must maintain your LLC's corporate veil.

LLC Tax Benefits and Options for a Software Development Business

LLCs, by default, are taxed as a pass-through entity, just like a sole proprietorship or partnership. This means that the business's net income passes through to the owner's individual tax return.

The business’s net income is then subject to income taxes (based on the owner's tax bracket) and self-employment taxes.

Sole proprietorships and partnerships are taxed in a similar way to LLCs, but they do not offer limited liability protection or other tax options.

S Corp Option for LLCs

An S corporation (S corp) is an IRS tax status that an LLC can elect. S corp status allows business owners to be treated as employees of the business (for tax purposes).

S corp tax status can reduce self-employment taxes and will allow business owners to contribute pre-tax dollars to 401k or health insurance premiums.

The S corp status requires that the business pay the employee-owner(s) a reasonable salary for the work they perform.

In addition, the business might need to spend more on accounting, bookkeeping, and payroll services. To offset these costs, you'd need to be saving about $2,000 a year on taxes.

We estimate that if a software development business owner can pay themselves a reasonable salary and at least $10,000 in distributions each year, they could benefit from S corp status.

You can start an S corp when you form your LLC. Our How to Start an S Corp guide will lead you through the process.

Credibility and Consumer Trust

Software development businesses rely on consumer trust. Credibility plays a key role in creating and maintaining any business.

Businesses gain consumer trust simply by forming an LLC.

A growing business can also benefit from the credibility of an LLC when applying for small business loans, grants, and credit.

Northwest will start an LLC for you for just $29 (plus state fees).

Get Started

How to Form an LLC

Forming an LLC is easy. There are two options for forming your LLC:

You can hire a professional LLC formation service to set up your LLC for a small fee
Or, you can choose your state from the list below to start an LLC yourself

Select Your State

For most new business owners, the best state to form an LLC in is the state where you live and where you plan to conduct your business.

Do LLCs Need Insurance?

All businesses need insurance to protect their business assets — even LLCs. This is because limited liability protection from being an LLC protects your personal assets, not your business assets.

Software development businesses need insurance to protect their business assets, employees, and customers. Insurance can provide liability protection in the event of a lawsuit or data breach, as well as coverage for any unexpected losses that may occur during the development process.

Common Situations Business Insurance May Cover for a Software Development Business

Example 1: While visiting your office to discuss a new project, a client slips on wet flooring in the restroom, breaks an arm, and decides to sues you for damages. General liability insurance policy would pay for your legal defense.

Example 2: Another software development business files a libel lawsuit against your company. General liability insurance would cover your legal defense costs.

Example 3: As an employee walks around a corner in your office, she accidentally runs into a visitor and knocks him to the floor. He breaks a wrist in the fall and asks you to pay for his medical treatment. General liability insurance would cover his medical expenses.

Other Types of Coverage Software Development Businesses Need

While general liability is the most important type of insurance to have, there are several other forms of coverage you should be aware of. Below are some other types of insurance all software development businesses should obtain:

Product Liability Insurance

While you strive to design software products that satisfy your clients, there’s always a chance someone might decide your product caused them injury. In the event of a lawsuit, product liability insurance would cover your legal fees and any required settlement.

Workers’ Compensation Insurance

Most states require businesses to carry workers’ compensation insurance for their part-time and full-time workers. This coverage protects your developers and other employees if they become injured at work or fall ill after a work-related accident. It not only covers an employee’s medical bills and lost wages if they need time to recover, but also any disability or death benefits stemming from a workplace accident.

Commercial Property Insurance

You made a major investment in the equipment, supplies, hardware, software, and real estate needed to run your business. In the event of a fire, theft, or natural disaster, commercial property insurance would cover the cost of repairing or replacing your business-related property. This includes structural damage to your building and the business materials stored there.

Commercial Umbrella Insurance

While your general liability insurance policy covers most claims, some accidents or lawsuits may be so catastrophic that they threaten to exhaust the limits of your primary coverage. Commercial umbrella insurance protects you from paying out-of-pocket for any legal fees and awarded damages that exceed your primary policy.

Should I Start an LLC FAQ

Choosing the right business structure depends on your business’s unique circumstances and needs. However, unless your business is very low risk (like a hobby), an LLC is likely the better option.

Visit our LLC vs. Sole Proprietorship guide to learn more.

At a minimum, you’ll need general liability insurance.

Read our Software Development Business Insurance article for more info.

The initial investment needed to start a software development business can vary from as low as $1,000 to very huge sums. This capital would go towards website hosting and data storage fees, copyright, trademark, and patent fees, specialized programs, and employee wages.

Visit our How to Start a Software Development Business guide to learn more about the costs of starting and maintaining this business.

Operating expenses for a software development business can include rent, payroll, utilities, and equipment.

Learn more about running a software development business.

Software development businesses make money by developing software and then either charging customers to use it or by embedding advertisements.

Learn more about starting a software development business.

Software development businesses can start small and focus on simple software, or they can employ a large team and develop more complicated programs. This provides some flexibility depending on your startup budget.

The average profit for a software development company varies depending on its size and the software that it makes, but earning potential is almost limitless.

Learn more about starting a software development business.