Have you ever wondered why your business is paying so much in taxes? Choosing the wrong business structure can cost you at tax time, and a tax adviser can help you make the right decision for your company. In particular, some business owners structure their business as a LLC, or limited liability company, and that model is not the best choice for them, especially if their business is a startup. Here are five reasons a LLC might not be the best business model for you, if your business is new, and an explanation of what a LLC actually is.
What is a LLC Anyway?
Many small business owners choose a LLC, considered a hybrid between a sole proprietorship and a corporation for their company, because of the personal liability protection offered, the same as for a corporation. It also requires fewer formalities and less paperwork.
A LLC doesn’t pay income taxes on profits, but must report any profits on its tax return. A LLC can be taxed as a Corporation, an S Corporation, or as a sole proprietor.
Being structured as a LLC works great for some business owners who want to be separate from the business, without dealing with the formalities corporations must, but it doesn’t work well for some companies. If you talk with a competent tax advisor, he may even say it is not the best option for you.
If Your Business is a Startup, Investors May Be Taxed in Other States
Does your business do business in other states than the one you operate in, or does it have an active trade? You may find that passive investors may have to pay income taxes in those states.
There Are Other Tax Implications for Investors in a LLC
Investors are partners. They will have to pay taxes on the business income even when no money has personally been distributed to them.
For Tax Reasons, Some Investors Won’t Be Able to Invest in Your Company
If your startup is a LLC, some investors, including those with venture capital funds, can’t invest in your company. This is because a venture capital fund has tax-exempt partners, and they are unable to receive business or active trade income because of their tax status.
Some Investors Would Rather Own Stock in a C-Corporation
Often investors in startups would rather make a simple investment and acquire a stock, which is for them a simple investment. That way they won’t have any tax complications until they sell the stock. Then they will have a capital gain or loss.
Often start-up owners will hear they shouldn’t form a C-Corporation because they have to pay a “double tax.”
True, a C-Corporation pays tax on net income, or income after salaries and expenses. True, if that company uses its net income to pay dividends to shareholders, they must then pay a tax on money received. Some experts, however, believe that new, growing business needs to raise capital, reinvest that money and grow quickly, grant equity incentives, and then be purchased or go public, the double taxation penalty won’t apply.
The Management of a LLC is not Easy
While some business owners like the structure of a LLC because of its flexibility and simplicity, but sometimes when you use that flexibility, you will actually find things are more complicated than anticipated. This is partially because the structure of a LLC consists of an agreement among the members of the business. This can be any form the members want, while a corporation is more structured. LLCshaven’t been around long, so there is not nearly as much case-law supporting them as for corporations. For that reason, it is hard to determine how courts or government agencies would view a particular agreement.
For more information, feel free to contact us.