Do I Need an LLC?

A limited liability company (LLC) is a popular organizational structure for small businesses. It combines the limited liability you get from a corporation with the tax and operational flexibility of a sole proprietorship or partnership.

But while an LLC provides small business owners with important legal protections, it's not needed for every entrepreneur or business entity.

Whether you need an LLC depends on your industry, your personal risk tolerance, and how you run your business.

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What Is an LLC?

A limited liability company (LLC) is one of many business structures available in the United States. It may consist of one or more LLC owners, who are referred to as “members.”

LLCs are generally accessible for most small businesses, with a few exceptions like banks and insurance companies.

The law treats an LLC as a business entity distinct from its members. As the name implies, an LLC limits its members' liability for legal judgments against their business — which means you have personal liability protection in the event of a lawsuit.

When Do You Need an LLC?

Every small business owner should strategically choose their business structure. This is to minimize operating expenses, tax burden, and personal liability.

Here are some circumstances when you should consider setting up an LLC:

You want to protect your assets

Unlike sole proprietorships, the law treats an LLC as a separate legal entity to the LLC owners, similar to how it treats corporations.

Hal Shelton, author of “The Secrets to Writing a Successful Business Plan” and a mentor for the non-profit small business education organization SCORE, believes an LLC’s combination of personal liability protection and limited bureaucracy is one of the main reasons it’s such a popular business structure

“An LLC has the same liability protections as a corporation, without a corporation’s administrative hoops to jump through, like having a board of directors, regular board meetings, and recording board minutes,” says Shelton. 

Low-barrier liability protection can keep an LLC member’s assets safe if the business is sued or burdened with debts.

For example, defaulting on a business loan with an LLC may lead creditors to sue and access funds in the designated bank account. However, funds in a personal savings account would be legally protected.

You have partners and/or employees

If your business is a one-person show, you may feel comfortable exposing your assets to liability as a sole proprietor. After all, you should be confident in your own behavior and business acumen.

But it’s a bigger gamble if the behavior of employees or business partners might put your personal assets at risk. 

A sole proprietorship can make you more vulnerable to the missteps of your business partners or employees. An LLC’s limited liability protection may give you peace of mind by separating your personal and business assets.

You want to pay less self-employment tax

An LLC member is typically responsible for paying their full share of Social Security and Medicare taxes, which currently amounts to a combined 15.3% of the member’s earnings from the LLC.

But you might be able to reduce your liability for self-employment taxes by choosing to have your LLC taxed as an S-corporation.

An S-corp allows you to categorize part of your business income as salary, which is subject to self-employment taxes, and part of your income as a distribution, which is subject to regular personal income tax.

That said, the IRS scrutinizes S-corporations, as some LLC members may abuse the S-corp loophole by designating a disproportionately high amount of profits as a distribution rather than salary.

S-corps may also be subject to additional state taxes, so it’s best to consult with a tax professional to determine if S-corp tax status would ultimately be to your LLC’s benefit.

If you're interested in pursuing S-corp status, a company like LegalZoom could help. They offer an S-Corporation formation service that can help you set everything up.

Form your S-corp with LegalZoom.

When Should You Consider Other Business Structures?

An LLC might not be the right structure for you if:

You’re not in a high-risk industry

Some jobs are at greater risk of litigation than others. About one in three physicians can expect to be sued in their lifetime, according to a 2023 study by the American Medical Association. 

On the other hand, if you’re a clothing designer, chances are low that one of your quinceañera dresses might so offend a client as to prompt a lawsuit.

Forming an LLC might be unnecessary when your liability risk is low.

Your business is more of a hobby

It can take time to generate revenue after starting a side hustle. But until your business becomes profitable, it might not be legally treated as an LLC, even if you registered it as such.

“It doesn’t happen very often, but the IRS could come and say: ‘This was never a business to begin with. It was a hobby.’ And then all those expenses that you deducted to reduce your taxable income, including your LLC registration fees, may get reversed, and you could have a big tax bill,” says Shelton.

READ MORE: How to Become a Freelancer: Side Hustle Pro Tips

You’re judgment-proof

If you don’t have significant personal assets — e.g., the balances in your personal bank accounts are quite low, your investments are minimal, and you don’t own a home — creditors can’t seize much from you in a court-ordered debt repayment, and potential lawsuits will have little to gain.

In this circumstance, you may not need an LLC’s liability protection. 

You have low bandwidth for bureaucracy and fees

“There’s an added expense for forming an LLC versus staying a sole proprietor. In most states, you’ll need to pay a registration fee that averages about $125 or so,” says Shelton. There is also an annual compliance report and fee you'll have to submit and pay.

Although forming an LLC isn’t as complicated as forming a corporation, there are some formalities, including:

• Registering a unique business name
• Designating a registered agent for correspondence
• Filing articles of organization

Though not required by all states, Shelton also recommends that anyone forming a multi-member LLC create an LLC operating agreement. This agreement can delineate member responsibilities, the process for adding new members, and the profit division.

READ MORE: How To Start a Business With No Money

You struggle with boundaries

Because you and your LLC are legally treated as separate entities, you’re expected to operate your LLC as a separate entity. That means using a separate business bank account and a business credit card for your LLC’s purchases. Also, always send business correspondence from your LLC’s email address. 

“If you tend to commingle your personal life and business life, and then you are subject to some kind of lawsuit … the plaintiff’s lawyer might say ‘You never operated your business as a separate legal entity,’” says Shelton.

Blurring the lines between the owner's assets and the formal business entity might invalidate your LLC’s liability protections in the eyes of the law and forfeit the LLC’s inherent purpose. 

READ MORE: Can You Put Personal Expenses on a Business Credit Card?

Is an LLC Right for Me?

Your decision to form an LLC will ultimately be informed by many variables. This includes your line of work, the state you live in, and your attitude toward your accumulated personal assets. 

This makes it impossible to provide cut-and-dry rules about LLC formation.

For objective advice on forming an LLC, seek experienced guidance. Covering various business structures will help you make an informed decision.

“Find a knowledgeable person you trust and talk your specific situation through with them,” advises Shelton. “Even if they are just a sounding board, verbalizing your thoughts can be very constructive.”

You can search SCORE's mentor database for mentors with business structure expertise. Then further filter the results by industry. SCORE's mentor access is free and available remotely or in person.

There are also companies that can help you through the process. LegalZoom, for example, offers an LLC formation service that walks you through setting up an LLC (or S-corp) step by step.

Form your LLC with LegalZoom.

FAQs

Do I need an LLC as a freelancer?

An LLC isn't mandatory for running a freelance business. If you work in an industry with low levels of litigation, your business isn’t generating significant revenue, or you lack substantial personal assets, a sole proprietorship may suit your needs.

How much does it cost to start an LLC?

The cost to form an LLC is based on LLC filing fees that vary widely from state to state. For example, Montana charges only $35 to file an LLC’s articles of organization, but filing for an LLC’s certificate of registration in Massachusetts costs $500.

What is a registered agent for an LLC?

A legally required representative, known as a registered agent or statutory agent, liaises with the government, court system, and the general public on behalf of an LLC. One of an LLC’s members can serve as its registered agent or the LLC can elect to hire a registered agent service instead.

The Bottom Line

If you have assets you need to protect, employees or business partners, or want tax advantages, an LLC may be right for you. But if you're in a low-risk industry or run a simple business on your own, it may not be necessary.

If you're unsure, talk with a tax or small business professional to decide what's best for you.

For more tips on how to best manage your business, check out these episodes of the Erika Taught Me podcast:

• 99% of Business Owners Make This Mistake
• How To Make Your First $100,000
• Marketing Expert Reveals Secret For Building an Audience That Buys

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