Don’t get me wrong. I think LLCs, or limited liability
companies, are great. At modest cost, they often let you
minimize your legal liability. LLCs also give you tremendous
tax flexibility, because with an LLC you can choose to be
treated as a corporation, an S corporation, a partnership (if
there are multiple owners), or a sole proprietorship (if you’re
the only owner).

In spite of these big benefits, four good reasons exist for not
forming a limited liability company for your next business. Here
they are:

State Income & Franchise Taxes

All states charge at least a modest fee—sometimes less than
$100—to set up an LLC. And that’s not so bad, but here’s what
is bad. Some states like California also levy additional unfair
annual fees and franchise taxes on even the smallest LLCs.

California’s minimum annual LLC franchise tax, for example, is
a whopping $800. Ouch.

If you’re operating in states with high annual LLC fees and
taxes, you need to think twice about using an LLC unless your
business is big enough to easily shoulder any extra fees and
taxes.

Complicated Bookkeeping and Accounting

For sole proprietors, an LLC may complicate your accounting if
you choose to have the LLC taxed as a regular corporation or an
S corporation.

This extra complexity stems from the fact that a corporate tax
return requires balance sheets once the business has more than
$250,000 in revenue or assets. And to produce a balance sheet,
you need to use correctly a full-blown accounting system such
as QuickBooks. Checkbook programs like Microsoft Money and
Quicken don’t really work.

Be careful that you don’t over-complicate your accounting
without good reason.

Extra Paperwork and Red Tape

A limited liability company burdens you with significantly less
red tape and paperwork than a corporation. Which is awesome.
However, an LLC still requires more paperwork than a simple
sole proprietorship. (Often a sole proprietorship requires no
paperwork.)

At a minimum, for example, an LLC will probably be required to
file annual reports with the state agency that supervises
limited liability companies and corporations. An LLC should
probably have an operating agreement. In some states, LLCs also
have the paperwork to file depending on the type of business.

Modest Liability Protection

Even if you operate your business as an LLC, you may not get
much liability protection if you do all the work yourself
(because you’re a one-man or one-woman operation) or if you
have to provide personal guarantees to lenders, customers and
vendors.

This may be you don’t get much or any extra liability
protection from operating as an LLC. This may mean that you
just need to be easily careful and have a good insurance
policy.

Closing Caveats

Limited liability companies are often the perfect platform for
a new business. But think carefully about using an LLC for a
very small business if you want to keep things extremely simple
and very cheap.

About the Author: LLC formation author & CPA Stephen L. Nelson
has written more than 150 books. Formerly an adjunct tax
professor at Golden Gate University—the nation’s largest
graduate tax school—Nelson is also the author of QuickBooks for
Dummies. Copyright © by 2006 by Stephen L. Nelson, CPA. Contact
him at http://www.stephenlnelson.com.

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