Four Reasons Not to Form a Limited Liability Company
Don't get me wrong. I think LLCs, or limited liability companies, are great. At modest cost, they often let you minimize your legal liability. LLCs also give you tremendous tax flexibility, because with an LLC you can choose to be treated as a corporation, an S corporation, a partnership (if there are multiple owners), or a sole proprietorship (if you're the only owner).
In spite of these big benefits, four good reasons exist for not forming a limited liability company for your next business. Here they are:
State Income & Franchise Taxes
All states charge at least a modest fee--sometimes less than $100--to set up an LLC. And that's not so bad, but here's what is bad. Some states like California also levy additional unfair annual fees and franchise taxes on even the smallest LLCs.
California's minimum annual LLC franchise tax, for example, is a whopping $800. Ouch.
If you're operating in states with high annual LLC fees and taxes, you need to think twice about using an LLC unless your business is big enough to easily shoulder any extra fees and taxes.
Complicated Bookkeeping and Accounting
For sole proprietors, an LLC may complicate your accounting if you choose to have the LLC taxed as a regular corporation or an S corporation.
This extra complexity stems from the fact that a corporate tax return requires balance sheets once the business has more than $250,000 in revenue or assets. And to produce a balance sheet, you need to use correctly a full-blown accounting system such as QuickBooks. Checkbook programs like Microsoft Money and Quicken don't really work.
Be careful that you don't over-complicate your accounting without good reason.
Extra Paperwork and Red Tape
A limited liability company burdens you with significantly less red tape and paperwork than a corporation. Which is awesome. However, an LLC still requires more paperwork than a simple sole proprietorship. (Often a sole proprietorship requires no paperwork.)
At a minimum, for example, an LLC will probably be required to file annual reports with the state agency that supervises limited liability companies and corporations. An LLC should probably have an operating agreement. In some states, LLCs also have the paperwork to file depending on the type of business.
Modest Liability Protection
Even if you operate your business as an LLC, you may not get much liability protection if you do all the work yourself (because you're a one-man or one-woman operation) or if you have to provide personal guarantees to lenders, customers and vendors.
This may be you don't get much or any extra liability protection from operating as an LLC. This may mean that you just need to be easily careful and have a good insurance policy.
Limited liability companies are often the perfect platform for a new business. But think carefully about using an LLC for a very small business if you want to keep things extremely simple and very cheap.
LLC formation author & CPA Stephen L. Nelson has written more than 150 books. Formerly an adjunct tax professor at Golden Gate University--the nation's largest graduate tax school--Nelson is also the author of QuickBooks for Dummies. Copyright © by 2006 by Stephen L. Nelson, CPA. Contact him at http://www.stephenlnelson.com.