Forming an LLC

There are lots of ways to describe the possible benefits of turning your sole proprietorship into a corporation, and for choosing an LLC among the possible entities you could form.

Here is one handy discussion of what the LLC offers your business:

An LLC is a combination of a partnership and a corporation. The owners of an LLC, called "members," get many of the same tax benefits as partners in a partnership and enjoy the limited liability benefits of a corporation.

Typically, unless the members choose otherwise, an LLC is taxed almost exactly the same way that partnerships or sole proprietorships are taxed. Profits and losses are "passed through" to the members of the LLC, and there is no income tax at the business level, or "double taxation."

That is, with a corporation, there is a tax on the corporation's net income, and then the corporation's shareholders (or stockholders) must pay individual income taxes on any dividends they receive from the corporation. With an LLC, on the other hand, the profits "pass through" to the members, and they pay income taxes at their individual tax rates.

Choosing the LLC form can bring you some significant tax disadvantages, however. For example, the profits you receive from the LLC most likely will be subject to self-employment taxes, which are designed to cover the Social Security and Medicare taxes that most employees have withheld from their paychecks.

Like a corporation, the members of an LLC are generally shielded from personal liability for the LLC's debts and obligations. This is perhaps the biggest reason why the LLC business form is so popular. So, for example, if the LLC takes out a business loan and is later unable to repay it, the creditor can't sue the individual members to recover payment on the loan.

There are some important exceptions to this rule, however. Most state laws do not shield members from personal liability on a debt or liability owed by the LLC when, for example:

• The member personally guarantees the repayment of a debt
• The members use the LLC to commit fraud
• A member is negligent in appointing or supervising a manager, employee, agent or other member of the LLC with respect to some action that causes harm or damages to a third party

Be sure to consult an attorney experienced in helping you set up your LLC. You'll need legal guidance as well as advice from a tax accountant. Don't just rely on the Internet!