This article discusses the most common myths about LLCs and gives you a better picture of this business type as an alternative to the corporate structure.
Myth 1: An LLC is a “limited liability corporation” and is the same as any other type of corporation.
The Truth: An LLC is a “limited liability company.” An LLC is similar to a corporation in its limitations on liability to the owners, but it has a different ownership structure (members instead of shareholders). An LLC is formed in a state with Articles of Organization or similar filing document, while a corporation is formed with Articles of Incorporation. While the two forms are similar in some ways, they are not equivalent.
Myth 2: I can set up my LLC in a state like Nevada and avoid paying income taxes.
The Truth: It is true that Nevada and six other states don’t have state income tax, but you still must pay federal income tax on your net income from your Nevada LLC. But if your LLC is doing business in another state, you must register with that state by forming an LLC in that state, paying the required state income taxes, state sales taxes, and fees. Doing business means you have a tax presence (called a nexus) in that state, by having property, selling products or services, having a bank account, or holding meetings in that state. You will also have to pay additional fees to your attorney and tax professional for reports and tax forms for multiple states.
Myth 3: Forming and running an LLC is difficult and complex.
The Truth: It’s much simpler to form an LLC than it is to form a corporation. The LLC must register with a state, but there are no shares of stock or reports to shareholders. Corporations must create and keep records on a variety of documents, including bylaws, minutes of shareholder meetings, and information about shares of stock. An LLC doesn’t need to keep a board of directors and file complicated annual reports. The LLC isn’t required to have a board of directors; it may be managed by the members or by a paid manager. There are no requirements for keeping records of their meetings. Of course, an LLC should always keep records of all transactions and decisions.
Myth 4: Corporations are a “safer” business type than LLCs for avoiding liability.
The Truth: LLC’s aren’t called “limited liability” for nothing. A limited liability company limits the liability of the owners to their investment in the company. A limited liability company is a separate entity from its owners, and its liability is separate from the liability of the owners unless something happens to cause the owners and shareholders personally to be sued. This concept is called “piercing the corporate veil,” taking away the separation between any business, not just a corporation, and its owners. A court might cause owners to have personal liability in cases where there is serious misconduct, like fraud or dishonesty, or a criminal act, or if it defrauds creditors.
Myth 5: An LLC is a business entity for tax purposes.
The Truth: An LLC is not a taxable entity. How an LLC is taxed depends on how many members are in the company. A single-member LLC is taxed as a sole proprietorship, reporting its income on a Schedule C as part of its personal tax return. An LLC with two or more members is taxed as a partnership. The partnership files information return on Form 1065 for the year. Then each member receives a Schedule K-1 showing their share of the partnership’s income, reported on their personal tax return. An LLC can also elect to be taxed as a corporation or an S corporation by filing an election with the IRS. This change in tax status doesn’t change the way the LLC operates.
