At some point, solo creators in the United States may ponder whether setting up a limited liability company (or LLC) for their business makes sense. In some cases, LLCs can be perfect for solos and small business owners. They are relatively easy to set up, and the entity governance formalities are much less onerous than those of a corporation. However, for others, the benefits may not be significant and may be outweighed by the inconveniences. Below are some positives and negatives to consider.
Positives.
Liability Protection.
Liability protection is probably the most obvious and talked-about benefit of setting up an LLC. However, it is not absolute, especially for a single-member LLC.
Over the years, the liability protections provided by LLCs have been gradually eroded by court rulings in which litigants are allowed to basically ignore the entity structure and go after the personal assets of the LLC owner or owners. This is often accomplished through the legal doctrine called "piercing the corporate veil." This "piercing" of the LLC structure is more likely to be allowed by a court where the LLC owner has some bad facts, such as evidence of the owner's fraud or other wrongful conduct, failure to follow LLC formalities (such as not having an LLC operating agreement), or failure to treat the LLC as a separate entity by not keeping LLC funds separated from personal funds. And where an LLC has just a single member, arguments that the LLC entity is nothing more than an "alter-ego" of the individual owner, and therefore should not be entitled to liability protection, seem to be more persuasive.
To be clear, even though the liability protection of an LLC is imperfect, it is still a significant positive. I would much rather have someone sue my single-member LLC than me personally any day. Just be aware that it is not guaranteed protection.
Help With Taxes.
I'm not suggesting that setting up an LLC alone will give you advantageous tax treatment. Single-member LLCs can, for instance, elect to be taxed as a corporation (which might be beneficial in certain circumstances), but that is not typical and is a complex topic to explore with a professional advisor. Instead, single-member LLCs are commonly treated as sole proprietor/disregarded entities for income tax purposes. The benefit I'm thinking about has to do with deducting business expenses.
Most of us will want the IRS to treat our enterprise as a for-profit business, rather than a hobby, so we can deduct business expenses from our revenues, thereby reducing our taxable income.
IRS Publication 535 lists factors for determining whether an activity is a business or a hobby, and the first factor is whether the taxpayer carries out the activity in a businesslike manner and maintains complete and accurate books and records. Organizing your business as an LLC (with an operating agreement specifying the business purpose and the assets of the business, and a separate bank account in the name of the LLC), might support a determination that the activity is conducted like a business rather than a hobby. This structure may cause you to be more disciplined about not commingling business and personal assets, which may also help make your activity look more like a business and less like a hobby.
As an aside, Pub. 535 describes the IRS's "presumption of profit," which provides that an activity is presumed to be carried on for profit, versus as a hobby, if it produced a profit in at least 3 of the last 5 tax years. For some businesses, such as a music production business where it can take a long time for the royalties to start trickling in, this can be a tough test to meet.
Protecting Your Brand and Trademark
If you've given your business a name, other than your actual name, then you should consider how to protect your brand and trademark. At a basic level, using your brand name in commerce is what establishes your trademark. You could also register with the U.S. Patent and Trademark Office, but that may be overkill for most solo creators.
Creating an LLC with your brand name in the entity name through a secretary of state office, however, is one way to create a public record of your brand name usage. Incidentally, many states also allow secretary of state trademark registrations without the necessity to create an LLC or corporation.
Please be aware, though, that just because a name you've chosen is available for registration with a secretary of state's office, this does not guarantee that you are not infringing on someone else's trademark. Always research your name thoroughly and select a unique name. You can also search existing trademarks (typically held by larger companies) through the US Patent and Trademark Office's online portal.
Giving Your Business and Brand More Legitimacy
This one is a bit subjective and very dependent on individual circumstances. Having a business brand separate from your actual name, and also organizing it as an LLC for the other reasons stated above, may create some intangible perception of credibility or legitimacy, especially if you pitch work to larger businesses or if you are trying to start an online community or other presence.
My personal take is that having an LLC can make you appear more serious and established than you might otherwise simply because setting up an LLC requires some extra work, expense, and time.
Negatives
Hassle Factor and Cost
I'm combining two negatives here, but they are related. Hassle factor and costs are probably the most significant negatives for most solo creators considering an LLC.
First, there is simply the cost and time to register the LLC with a secretary of state office. Costs for this initial filing vary by state, but typically you're looking at no more than a couple hundred dollars.
Be aware that if you organize in a state other than your state of residence and then undertake activities locally - such as leasing office space or offering in-person services, for instance - you might find that you need to also register your out-of-state LLC with the secretary of state in your state of residence (typically a lesser fee). In other words, this could lead to more hassles and costs.
Then each year, you'll need to file an annual statement to keep the LLC active, which usually is less than the initial fee to create the LLC, but is still one you'll have to pay as long as you keep the LLC in place.
You could also incur professional fees (attorney, CPA, etc.) if you need advice or assistance for your specific circumstance. For instance, you might want some help creating an operating agreement. I will point out, though, that an operating agreement for an LLC owned by multiple members is more complex than an operating agreement for a single-member LLC due to the potential for future disputes among the multiple owners. For a single-member LLC, you're basically just documenting the business purpose and assets of the entity, and your status as a member and manager of the entity, as applicable.
Added Layers of Complexity
In addition to the negatives listed above that can add some complexity to your business, there may be other layers of complexity to consider. For instance, if the business is entering into a contract, you'll need to list the LLC as a party to the contract and sign on behalf of the LLC as a member or manager, as applicable.
Also, I have run into situations in the context of my music production business where third-party entities I deal with have differing policies regarding my LLC. For instance, Sound Exchange, an entity that collects digital performance royalties for sound recordings, would not allow me to register to allow collected royalties to be distributed directly to my LLC bank account because, as a single-member LLC, the IRS treats my business as a sole proprietorship. So, I'll simply have to receive any collected funds in an individual account and funnel them into my LLC account - a slight inconvenience that also makes my record-keeping less streamlined.
Take-Aways
If you are still on the fence about creating an LLC, I would suggest you step back and ask yourself "Am I engaging in activities, or entering contracts, where getting sued or having a legal dispute is a real possibility?" If the answer is "yes," then the liability protection of an LLC may be worth pursuing despite the hassle and costs. If the answer is "no," then maybe it is not worth it unless some of the LLC positives of an LLC are compelling for you, or you might just want to wait until your business grows.
Regardless of which direction you decide to go, I hope this provides a useful framework for pondering the matter, and for deciding if you need to seek professional advice.
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