Why You Shouldn’t Form an LLC (And Why You Should)

 

Congratulations, you’ve started your own business! No more bosses telling you when to show up. Maybe you’ve been operating as a sole proprietor, but you hear about all these tax savings if you set up some sort of an entity for tax purposes. Between corporations, LLC’s, partnerships, and S-Corps, where do you start?  

Chances are, if you are going to remain a sole-owner, you should setup an LLC with your Secretary of State. Also, it’s good to get a lawyer who can help you plan for the closing up when that needs to be done.

But, not so fast, there are some important reasons you shouldn’t set up an LLC. Here is a short list of some of the reasons not to and some of the reasons you may want to form an LLC.

 

Reasons _Not_ To Set Up an LLC

  1. To save on federal income tax
    • An LLC is what’s called a “disregarded entity” for federal income tax purposes. That means your federal income tax will not be different as a single-member LLC than it was as a sole proprietor. You will report your income and expenses the same way as a sole proprietor does on a Schedule C of your 1040. The only difference is you’ll have additional expenses related to setting up and maintaining the LLC. So, technically your tax could be a bit lower.
  2. Additional filings and fees
    • You will have to manage more paperwork, pay additional fees, and may have to pay additional taxes to your state(s).

  3. More to wrap up if you close

    • Closing down an LLC requires additional steps if you move, close your doors, or otherwise wind up the company.

  4. New EIN required (if you’ve been using your SSN as a freelancer)

    • You need a  new EIN to open bank accounts and for your W9s. Again, more paperwork.

  5. New bank accounts need to be set up

    • If you’ve been operating under personal accounts and your SSN, you’ll want to close those and open new ones with your new EIN and your LLC name.

  6. Still liable for personal actions you take even if you set up an LLC

    • An LLC protects you from some liability. If you personally commit a crime in the course of doing business, you’re still liable. Moreover, lenders won’t give an LLC with no history money. So, you’re likely personally signing for any loan, credit card, or rental agreement anyway.

Ok, that’s a lot of reasons not to, but what about all the reasons you should open an LLC?

Reasons To Set Up an LLC

  1. Liability protection

    • You do get a level of liability protection as an LLC that you don’t as a sole proprietor. If you work in a particularly litigious field, it’s more likely that you may benefit from having some sort of additional protection. If you own a home, have substantial assets in stock or retirement, then it may be worthwhile to set up an LLC regardless to protect those assets. Entity selection options (S-Corp or Partnership)

  2. Entity selection options

    • You can elect to become an S-Corp later or if you already have an LLC. This can be an effective way to save on self-employment taxes, but be aware, an S-Corp has a lot of stringent record-keeping requirements, items to track, and tax compliance rules. An LLC is more flexible with fewer rules.

  3. Increased perceived legitimacy

    • Other businesses or vendors may view you with more legitimacy. Heck, you might even feel more legit.

  4. Lenders may be more interested

    • Lenders and other vendors may take into account how serious you are about your business. Having separate bank accounts, setting up bookkeeping, and establishing an LLC are all great ways to prove you’re in it to win it.

  5. Increased division of personal and business property and activity

    • Keeping your personal life separate from your business life is one of the biggest struggles as a freelancer or self-employed person. Having an LLC helps draw a line in the sand for yourself and some other outsiders. This can be a healthy relief!

Overall, if you’re organized, plan to make this your livelihood for the long haul, it’s likely in your best interest to set up an LLC. It’s not too difficult to do on your own, but we recommend using a trusted lawyer to help get things set up properly. If you don’t, you could be exposing yourself to additional risk.

If you’re simply generating additional income as a hobby and not spending much time, or money, on it, then it may not be worthwhile. Again, it depends on the whole picture. How much do you have at risk? How risky is your line of work?

If you need to talk through any of these considerations, feel free to book a call or else contact a trusted lawyer or CPA.

 
Luke Frye