7 LLC Myths You Need to Know
The limited liability company continues to gain more and more popularity, and every day thousands of them are formed around the country. Entrepreneurs love the LLC because it fills a bit of a middle ground between the inflexible formal nature of the corporation, and the sole proprietorship or general partnership, which are often considered to be too casual for many businesses.
You can form your own LLC using resources found on official state business websites, or you can hire an LLC formation service to create your limited liability company on your behalf. No matter which of these options you choose, you might be surprised by how frequently we hear entrepreneurs discussing common misconceptions of the LLC as a business type.
In this article, we’ll discuss seven of the most common myths regarding limited liability companies. From the formation phase all the way through the business life cycle, there are some misguided statements that we hear quite often, and we’ll debunk them one by one.
With that, let’s look at some misconceptions about limited liability companies that have worked their way into the mainstream of American entrepreneurship.
1) Forming an LLC Is Complicated and/or Difficult
First off, let’s talk about the formation process itself. To form an LLC in most states, all you’ll need to do is fill out a document known as the articles of organization, which is where you outline some specifics about your business, including the physical location, the identities of the members/owners, and the name and location of your LLC’s registered agent.
You will also need to ensure that your desired business name is available in your state, and hasn’t already been claimed by another entity or individual. In addition, you’ll be required to pay your state’s LLC filing fee, which ranges from as little as $50 in some states to several hundred dollars in others.
If that sounds like too much of a hassle, you always have the option of hiring a business formation service like Northwest Registered Agent or IncFile. These companies can do all the heavy lifting for you, by drafting and filing your articles of organization so that you can focus on actually running your new business.
2) Forming an LLC in Another State Helps Avoid Taxes
We’ll readily admit that it can be quite tempting to form a limited liability company in a state that’s considered to be a “tax haven” like Nevada or Wyoming. However, the advantages of forming a business in these states can often be drastically overstated.
If your business doesn’t actually operate in the state you form it in, you’ll still need to pay taxes in the state where your LLC does business. For example, if you and your company are located in New York, and that’s where you conduct your business transactions, it doesn’t matter if you formed your business in Nevada ― you will still be responsible for taxes on your New York-based business dealings.
Furthermore, if you do choose to form your LLC in another state, you’ll still need to register it as a foreign LLC in your own state. This means that you may actually be subject to more fees and compliance responsibilities than you would be if you had simply formed an LLC in your home state. Long story short, forming a limited liability company in a different state as a means of avoiding taxes is often a losing bet.
3) Home-Based and Single-Owner Businesses Don’t Need to Form LLCs
We often hear people saying that they don’t think they need to form a limited liability company (or any other formal business structure, for that matter) because they are simply operating a home-based business with no employees. Why would anyone in this position need to pursue LLC formation?
The problem with this mindset is that it minimizes the potential liabilities your business may have. It doesn’t matter if you’re running your business out of your own home, or whether you have employees or not. If you have any liability to your clients and customers, it’s probably a good idea to start an LLC.
With a sole proprietorship, your personal assets are not protected, which means that if your business is sued, you will be held personally liable for any settlement or judgment. If you form an LLC, in many cases your limited liability will be upheld, meaning that a creditor could only pursue your personal assets amounting to your investment in your business.
It’s easy to see how a sole proprietor could be financially ruined by just one lawsuit, whereas an LLC owner/member would certainly still be inconvenienced, but the limited liability provided by this business structure would still protect your personal assets and allow you to keep your house, car, personal bank accounts, etc.
4) LLCs Cannot Be Publicly Traded
Many entrepreneurs believe that only corporations can be traded publicly, but this just isn’t true. We will agree that corporations are certainly easier to trade, but with the proper expert assistance, you can go public with a limited liability company as well.
Because LLCs are allowed to decide how they want to be taxed, you could choose to structure your LLC as a partnership, and you can then trade ownership shares in your company on a securities exchange. With this method, you would need to market your business as a publicly traded partnership rather than as a limited liability company, but your company would still benefit from the asset protection afforded by an LLC.
Just to be clear, this is not exactly an easy route to take, and it’s not a common one either, as most publicly traded partnerships operate in the industries of energy and natural resources. There are also some restrictions, like the rule that a publicly traded partnership can only trade up to 2% of its partnership shares per year, or the limitation that this business type must have fewer than 100 partners.
In short, while it’s a bit of a convoluted process to publicly trade an LLC, that doesn’t mean that it’s impossible.
5) LLC Owner/Members Must Be American Citizens or Residents
Do you need to be an American citizen to own and operate a limited liability company? Nope. Do you need to at least live in the United States? Again, the answer is no. It doesn’t matter where you reside or where you have citizenship status, the process of LLC formation is no different whether you’re American or not.
The only major distinction when it comes to LLC ownership between US citizens and non-citizens is in the area of taxation. Because a non-citizen does not have a Social Security number, these owner/members must acquire a taxpayer identification number (TIN) from the IRS in order to be able to lawfully pay taxes on LLC income.
Beyond that, there are really no significant differences between citizen and non-citizen limited liability company ownership.
6) The LLC Is Only Suitable for Small Businesses
To debunk this myth, we don’t need to look any further than Amazon, one of the world’s largest and most dominant companies. While Amazon.com, Inc. is a corporation that operates as the parent company, Amazon uses LLCs for many of its subsidiaries.
By owning limited liability companies located in several different states, Amazon is able to reduce its total tax liability while also decreasing the legal liability shouldered by its ownership group in case of a lawsuit settlement or judgment. Because of this arrangement, if one of their subsidiary LLCs is sued, the parent company is protected from sharing that liability.
While this example obviously doesn’t apply to many of our readers (unless Jeff Bezos himself is reading this…hi, Jeff!), it is a good way to illustrate how the LLC is certainly not just for the small business owner. As a major corporation that is subject to corporate income taxes and operates in several different states, Amazon still finds that the LLC is the right structure for their subsidiaries.
7) The LLC’s Corporate Veil Provides Unlimited Personal Asset Protection
We’ve saved what is potentially the most dangerous misconception about limited liability companies for last. The corporate veil is another term for the LLC’s limited liability protection, and it has its legal limits. There are situations that can lead to the courts “piercing” your corporate veil, leaving your personal assets unprotected from creditors.
While there are too many circumstances that can lead to a piercing of the corporate veil to dive into them all in-depth in this article, in general these are the main limitations of an LLC’s ability to limit your personal liability:
- Your LLC is merely an extension of you as a person, rather than a separate entity
- The LLC is used in a fraudulent manner
- Creditors are unjustly damaged by your LLC
If a court determines that you violated your corporate veil in any of the above manners, you could lose your limited liability protection, and creditors will be able to pursue your personal assets, including your house, car, and personal bank accounts.
Even with the limited liability company being as popular as it is, there are still quite a few common misconceptions about this business entity.
In reality, the corporate veil has its limitations, the LLC is not just for small businesses, you don’t have to be an American citizen or resident to own an LLC, an LLC can be publicly traded if set up correctly, forming an LLC in another state usually doesn’t help you avoid taxes, and just because your business is home-based or single-owner doesn’t mean you shouldn’t form an LLC.
We hope this article helped you discover the truth behind these common myths about limited liability companies, and we wish you the best of luck in your business future ― regardless of whether or not the LLC is the right choice for your company.