Many times, the more popular something gets, the more rumors spread about it, and the limited liability company (LLC) is no exception.
Since its conception, the LLC has increasingly gained popularity in the U.S. and now, thousands of them pop up around the country every day.
And with the LLC’s rise, some myths have also appeared surrounding it. And we’re not talking urban legends and ghost stories, but the consequences can still be frightening if you happen to fall for one of them.
Entrepreneurs love the LLC because it fills the middle ground between the corporation’s inflexible formalities and the casualness of the sole proprietorship or general partnership. It provides a solid business framework that also offers some flexibility.
You can form your own LLC using resources provided by official state business websites, or you can hire an LLC formation service to form your business. No matter which option you choose, you might be surprised by how frequently we hear entrepreneurs discussing common misconceptions of the LLC as a business type.
This guide will serve to protect you against these misconceptions. Read carefully and you’ll be armed with the knowledge necessary to avoid falling for these myths and harming your budding LLC. 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.
By the end, you’ll be able to confidently navigate your LLC’s formation and operation, avoiding all the common pitfalls along the way.
If you need help starting an LLC or just want to make sure it’s done correctly, hire an online LLC service like ZenBusiness ($39) or LegalZoom ($99). They take care of all the legal paperwork so you can focus on what you do best.
Tip: ZenBusiness is the best deal and scored higher than any other LLC service.
1) Forming an LLC Is Complicated and/or Difficult
First things first: 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 called the Articles of Organization. While the Articles of Organization varies from state to state, it most often requires the same general information: the physical location, the identities of the members/owners, and the registered agent’s name and address.
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. Otherwise, you’ll need to get creative and come up with something new. On top of that, each state has an 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 ZenBusiness. These companies can do all the heavy lifting for you, drafting and filing your Articles of Organization so that you can focus on actually running your new business. Trying to DIY your LLC’s formation? Take a look at our in-depth formation guide.
2) Forming an LLC in Another State Helps Avoid Taxes
There’s no denying that it can be 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 are often drastically overstated.
If you form a business in one state, but operate it in another one, 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 business, it doesn’t matter if you formed your business in Nevada ― you will still be responsible for taxes on your New York-based transactions.
Furthermore, if you 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. For most businesses, the best move is simply forming your LLC in your current state.
3) Home-Based and Single-Owner Businesses Don’t Need to Form LLCs
We often hear entrepreneurs say that they don’t think they need to form a limited liability company (or any other formal business structure) because they are simply operating a home-based business with no employees. Why would anyone in this position need to pursue LLC formation?
The answer: limited liability protections. Sole proprietorships simply don’t offer the same security for your personal assets. So, if your business is sued, you will be held personally liable for any settlement or judgment and creditors could come after your house, car, savings, or other possessions, leaving you in financial ruin. If you form an LLC, however, 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 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.
4) LLCs Cannot Be Publicly Traded
Most entrepreneurs know that corporations can be publicly traded, but a lot fewer know that LLCs can too. Of course, it’s much easier to trade with a corporation, 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, then trade ownership shares in your company on a securities exchange. This method requires you 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.
We’ll be straight with you: this is not exactly an easy route to take, and it’s not a common one either. Most publicly traded partnerships operate in the energy and natural resources industries. Plus, there are some restrictions, like the rule that a publicly traded partnership can only trade up to 2% of its partnership shares per year, or that this business type must have fewer than 100 partners.
It’s a convoluted process to publicly trade an LLC, but they say where there’s a will, there’s a way, and you can certainly trade your LLC if you’re committed to doing so.
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? No again. The LLC formation process is no different whether you’re American or not.
When it comes to LLC ownership, the only major distinction between U.S. citizens and non-citizens is in taxation. Because non-citizens do not have Social Security numbers, they must instead acquire a taxpayer identification number (TIN) from the IRS to lawfully pay taxes on LLC income. The TIN operates identically to an SNN, it simply serves to identify the business owner on any necessary tax documents.
Beyond that, U.S. citizen or not – it doesn’t matter. LLC ownership is essentially the same.
6) The LLC Is Only Suitable for Small Businesses
To debunk this myth, we don’t need to look any further than one of the world’s largest and most dominant companies: Amazon. 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 in several different states, Amazon reduces its total tax liability while also decreasing the legal liability shouldered by its ownership group in case of a lawsuit settlement or judgment. This is a smart move because if one of their subsidiary LLCs is sued, the parent company won’t need to share that liability.
This example obviously doesn’t apply to many of our readers (unless Jeff Bezos himself is reading this…hi, Jeff!), but it’s a good way to illustrate how the LLC is not just for small business owners. As a major corporation, subject to corporate income taxes and operates in several different states, Amazon still finds that the LLC is the right structure for their subsidiaries.
Whether you’re forming a subsidiary for an industry giant or you’re selling hand-made dog sweaters out of your garage, an LLC could be the right option for you.
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. Earlier, we mentioned the LLC’s limited liability protection, and another name for it is the “corporate veil.” This veil is durable, but it’s certainly not impenetrable. Certain situations can cause a court to “pierce” it, leaving your personal assets open to creditors.
There are so many circumstances that lead to the piercing of your corporate veil that we could write a whole guide on it, and we did! But for the purposes of this list, we’ll just give a brief overview. In general, your LLC’s corporate veil can be pierced if:
- Courts can prove that your LLC is merely an extension of you as a person, rather than a separate entity
- The LLC has been used in a fraudulent manner
- Creditors have been unjustly damaged by your LLC
If a court proves any of these things, 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 though the LLC is one of the most popular business structures in the U.S., there are still a lot of misconceptions about it. But now you’re aware and can avoid falling prey to them!
Let’s review those correct answers rapid-fire: 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.
You may have heard another entrepreneur mention one or more of these misconceptions about LLCs, and if so, don’t listen! Then, show them this guide. Keep this information in mind and you won’t lead your company astray.