Starting a side business? Forming LLC could be a good first step

“Corporation, n., an ingenious device for obtaining individual profit without individual responsibility.”
–Ambrose Bierce, the Unabridged Devil’s Dictionary.

 

Regrettably, Limited Liability Companies (LLCs) were not included in Ambrose Bierce’s popular quote from 1910 because LLCs didn’t exist in most states until the 1990s.

Still, the quote applies to LLCs in the same way as corporations. And, LLCs have become much more popular since their creation.

Let’s imagine you are contemplating a new business endeavor.

Perhaps it’s the food truck idea that has been percolating in your mind for years to supply food for local events.

Maybe you want to start up a lawn maintenance company on the weekends outside of your regular job hours. Perhaps you have an idea to start an electric bike rental company. Whatever the passion, should you get yourself a corporate form of doing business?

What kind should you get?

Does the entrepreneur even need an entity like a corporation or an LLC?

Legal protections

The key to choosing to establish an entity is the legal protection it provides. That is, the owner is not held personally liable for the debts or liabilities of the company. Accordingly, conventional wisdom dictates establishing an entity for any business endeavor.

The main forms of doing business through an entity are: (1) C corporations taxed under subchapter C of the Internal Revenue Code; (2) S corporations taxed under subchapter S of the Internal Revenue Code; (3) limited partnerships – taxed as pass-through entities; or (4) limited liability companies (LLCs) – taxed any way you want.

To clarify the last option, let me explain.

An LLC can elect to be taxed as: (1) a C corporation; (2) an S corporation; (3) a partnership (pass through taxation); or (4) a so-called disregarded entity (also pass-through tax status).

If the entity is owned by only one person, then the partnership tax status is unavailable. Likewise, if the entity is owned by more than one person, then the disregarded status in unavailable.

Four types of entities and four tax treatments.

Beyond liability protection, the entity also provides a more seamless business experience for anyone working for or dealing with the business.

The entity will have its own tax ID number so the owner’s social security number isn’t usually necessary for business transactions. The entity also provides an opportunity to structure the rights and obligations of any co-owners in a recognizable fashion through entity organizational documents (things like the operating agreement or shareholder agreements).

How to choose?

So, should the entrepreneur choose a corporate form of doing business or the limited liability company?

Since their inception in the 1990s, LLCs have slowly but surely begun to outpace the corporate form of doing business.

A quick perusal of the Washington Secretary of State new business entity filings reveals as much. In the past year, the registration of new LLCs far outpaced the registration of corporations (or limited partnerships for that matter).

For the one-year period ending Sept. 30, 2021, there were 77,860 new entity registrations for LLCs compared to only 5,478 for corporations. By my crude math, that is a 15:1 ratio.

As noted above, LLCs provide great flexibility when choosing how to be taxed. Plus, they offer great flexibility with regard to governance and operations.

Taken together, the choice of entity often points to the LLC. It’s a vehicle that can accommodate many types of businesses and enterprises. And, if unsure which to pick, the LLC is a good default choice because of that flexibility.

LLCs are not right for everyone or every situation of course.

Though the taxability is very flexible, LLCs are not a great choice for high growth (think technology) companies that might eventually seek external funding and listing on a stock exchange – C corporations are required for that.

The tax benefits usually attributable to other forms of doing business (i.e., S corporations and C corporations) are not decisive because the LLC (as note above) can choose its tax treatment to copy those same tax benefits.

Of course, all this presupposes that you are not an employee for this side job working for someone else. An employee does not have the option to form an entity like an LLC through which to conduct business. An employee is only able to act as an agent of the employer as a W-2 (wage earning) employee.

If you are going to start a side job and want the benefit of liability protection, an LLC is a great place to start. Talk to your tax and legal advisors for more details.

Beau Ruff, a licensed attorney, is the director of planning at Cornerstone Wealth Strategies, a full-service independent investment management and financial planning firm in Kennewick.

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