Before jumping into the cons of LLC’s, let us refresh ourselves with the LLC Basics:
The LLC Basics
An LLC is a business entity usually characterized as a partnership that wants protection like a corporation. Generally, they involve small, one, two or three-person operations. However, I have created LLC’s for franchisees that will have many business locations and employees. Many choose it because it helps to limit the liability of its members (the people involved in LLC), and it gives the tax flexibility of a sole-proprietorship or partnership. In most cases, profit and losses “pass through” the LLC to the members’ individual taxes.
Another important feature of an LLC is the limitation of liability. Each individual member’s liability is limited to his/her investment in the company. This protection is not available to a sole-proprietor or a partner who is liable for all the debts of the LLC. At the same time, an LLC will not always protect a member, or an LLC employee, from his or her negligent acts.
Now, let us look at the cons to an LLC:
One of the cons of an LLC, as opposed to a corporation form, is that the IRS limits the ‘characteristics’ that your LLC may have. An LLC may only have two of the four characteristics that define corporations: Limited liability to the extent of assets, Continuity of Life, Centralization of Management, and Free transferability of Ownership Interests. Therefore, if you wish to have more than two of these characteristics, you’ll need to convert to a corporate business structure.
Usually, a characteristic that is not utilized is Continuity of Life. Commonly, LLC will have a limited life. Therefore, when a member dies or undergoes bankruptcy, the LLC will often be dissolved in some manner, including sale to a new party. Typically, you would determine in advance the length of the LLC’s duration when you file it with your state. If your plans include taking your company public or issuing shares to your employees, essentially prolonging its life, then you would need to convert to a corporate business structure.
Another characteristic that is not common in LLC’s is the free transferability of ownership. Most LLC are family organizations, and the members do not want outsiders to become members. Therefore, it becomes important to have an operating agreement that spells that out.
Therefore, in most LLC’s, the characteristics of limited liability and centralization of management are maintained. However, check your statutes. Some states do allow an LLC to have more two characteristics and still maintain its LLC status and protections.
Also, the owner of an LLC is considered to be self-employed and must pay the 15.3% self-employment tax contributions towards Medicare and social security. As such, the entire net income of the LLC is subject to this tax. If two or members who receive an equal share of the net profits, then each member will bear the burden of self-employment tax.