Nobody stops you during critical life events involving serious financial consideration and says “Now is a good time to create a Limited Liability Company.” It is literally one of the greatest tools in the world of business and personal finance and yet many people don’t know when or even how to use them.
Here are some of the reasons you might want to create an LLC:
- Starting a new small business.
- Avoiding various forms of Taxation (Which is legal).
- Protecting Assets that generate passive income.
- Protecting personal assets from risk or exposure to an owners lifestyle choices.
We are going to explore the reasons for creating an LLC and by the time we’re done, you will know when to create one thereby enjoying its many benefits.
LLCs didn’t become available to persons in the US until 1977, in which Wyoming was the first state to adopt it’s legal form. Each state’s statutes are different with regards to the governance over an LLC created in that state. This makes it imperative that you truly understand what your rights and risks are with regard to owning an LLC in a certain state. Even though the laws didn’t begin to fine tune their use until the 1990’s, LLC’s have become an imperative instrument to people in varying degrees. From savvy serial entrepreneurs, to passive investors, to small business owners that maintain a wide range of asset types, LLC’s can shield anyone from grave financial risk when used properly.
So let’s explore it’s use in the scenarios’ mentioned above:
1. Starting a New Small Business:
It’s no secret, at this point, if you have been contemplating a small business idea somewhere in the conversation somebody said that you needed to get an LLC. But why? Well creating a business entity means that you are now exposed to a greater realm of risk and liability than you were before. Your business is going to operate in a local, state, or maybe national economy and this means that whoever uses your service, or buys your product will potentially be negatively impacted by your business.
This isn’t because you intended harm, but the way in which harm is interpreted by today’s standards comes with a great degree of variability. By creating an LLC, you now limit an affected party’s ability to seize or access a member’s personal assets. This also means that the members of an LLC are only responsible for a company’s debts to the extent of each member’s contributions in that LLC.
2. Avoiding various forms of Taxation (Which is Legal):
Taxation is the dreaded word that almost everyone cringes at the sound of, except for greedy politicians. No doubt, the US tax code is exhausting, and navigating its trenches can be cumbersome. An LLC has two main types of tax avoidance that any entrepreneur should be aware of.
First, unlike a C-Corp an LLC typically takes the form of a pass-through entity, which means there is only one type of federal income tax. That tax happens at the member level when the net activity of that LLC is reported to them on a K-1 statement. Typically members/shareholders in a C-Corp have to pay Dividends tax on the distributions of its accumulated earnings at 15%. As a pass-through entity(LLC) you will avoid what has commonly been called Double Taxation by escaping the Dividends tax.
The second type of tax avoidance would be on self-employment taxes. As an LLC you have the option to elect to be an S-Corp. S-Corp’s are unique in that as an owner you can pay yourself a wage. This wage will need to be determined through the skills of a qualified tax accountant using what the IRS calls the “reasonable wage” principle. By cutting yourself a wage you now limit the amount of self-employment taxes you pay on your net income at 15.4%. By employing the right tax preparation service you can now avoid two types of taxes that claw at your precious profits.
3. Protecting Assets that generate passive income:
It has become increasingly popular in modern times to create a network of assets that can generate passive income. Passive income is the “golden ticket” in most financial coaching programs, as you limit your financial interest to a lower tax rate and create positive cash flows for reinvestment. However, just like your small business, without an LLC to put these assets in, they are still connected to you personally. This means any potential liability or suit can seize the assets that are not silo’ed properly in an LLC.
An example is someone who is growing a network of rental homes or commercial properties. Most passive income participants go a step further and create an LLC for each rental asset individually. This prevents rental assets from being commingled and therefore subject to greater liability within the operations of that rental asset and its use.
4. Protecting personal assets from risk or exposure to an owner’s lifestyle choices.
Did you know that you don’t have to subject the equity in your home to personal liability? That’s right, homes or estates that have been in the family for years and that you may have retained through inheritance don’t need to be subject to personal liabilities of its owner. You could injure someone in public through the use of your motor vehicle or other means. You could get into a physical disagreement with someone in a store which might lead to injury or death. Either way within a few short moments and a series of bad decisions, you now have subjected all the equity you hold in assets owned personally to the judicial outcome of that legal dispute. The answer: create an LLC for the simple purpose of protecting those assets that typically have substantial value. Obviously this type of LLC use is one that takes a great degree of consideration and you will need to evaluate individually whether it is worth the time and effort to create an LLC for this purpose.
Simple Start is a premier provider in LLC origination. We like to think that our knowledge and expertise stand apart from our competition. We will help you navigate the legal framework and ensure that your LLC takes shape in a way that will serve its intended use. People often think that an LLC is just some form you file with the state, however, this couldn’t be farther from the truth. Allow us to help you create an LLC that serves as a valuable tool in protecting your financial interest in whatever form that will follow.