An LLC is a business entity that provides both limited liability and relatively flexible tax treatment. An LLC with more than one member generally is treated as a partnership (eligible for pass-through taxation) by default for US federal income tax purposes, but it can elect to instead be treated as a C corporation. Though subject to certain restrictions, this flexibility can make LLCs a useful tool for building tax-efficient business structures. An LLC with just one owner is treated as a “disregarded entity” for tax purposes; it is not recognized as a separate tax entity but instead treated as owned and operated by its owner, absent an election to be classified as a C corporation.
Although LLCs have some attractive features, they can also present a number of disadvantages to startup company founders relative to a C corporation, for example:
- Most venture capital and other institutional investors are less willing to invest in an LLC (except for an LLC that has elected to be taxed as a C corporation).
- LLC formation documents are less standardized which can drive up the cost of documenting the formation and organization of an LLC
- Employee equity structures are more complicated which can increase the cost of issuing employee equity and make it more difficult for employees to understand the nature of their interest in the company.
- Investors generally cannot get QSBS tax benefits with respect to any LLC interests they hold (for more information about QSBS, see this article). QSBS treatment may be available if the LLC has elected to be taxed as a corporation.
Last reviewed: October 25, 2022