7 Pros and Cons of LLCs for General Contractors (and 2 Tax Options to Consider)

Walt Disney once said, “The way to get started is to quit talking and start doing.”

When it comes to setting up your business, though, there are several ways to “start doing.” You may have a great idea and be really excited about taking your first steps, but what direction should you head off in?

It can be confusing.

Sole Proprietorships, Partnerships, and Limited Liability Corporations (LLCs) are some of your options when it comes to forming an official business entity. (You can click on the links to take a look at posts where we’ve already discussed those.)

In this post, we’ll dig into the pros and cons of LLCs for general contractors. If this is something you’re considering for your business, you’ll especially want to read on and look at LLC options and their tax implications.

Pros and Cons of Starting LLCs for General Contractors

An LLC basically is a combination of a partnership and a corporation. When you structure your business this way, you enjoy the tax advantages of a partnership as well as the limited liability of a corporation.

LLCs operate in the business world exactly the same way that any human being can. They can open bank accounts, enter into contracts, hire and fire employees, own property, etc.

LLCs are made up of “members”, the legal term for the owners of the business. When you form the organization, you are required to list all of the members. They can be individuals or other businesses, and there is no limit as to how many members an LLC can have.

Pros of Starting an LLC Include:

  1. Limited Liability – An LLC essentially functions as it’s own individual entity. It controls all of its own assets, income, and liabilities. Therefore, all of the personal assets of the members are protected.
  2. Pass-through Taxation – All of the profits of an LLC go directly to the members (unless they agree to set it up differently), so federal taxes are only paid by the members on their personal tax returns.
  3. Flexibility – Members of an LLC can decide if they want to be directly involved in the day-to-day operations of the business or if they want to hire a professional manager who may have more experience.
  4. Easy to Start – State requirements may vary, but generally speaking the paperwork and fees involved in starting an LLC are very simple. Many business owners choose to do it themselves, but it is always wise to consult with an attorney or your CPA first.

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Cons of Starting an LLC Include:

  1. Limits on Limited Liability – If an LLC is found to be involved in shady or illegal business practices, a court may rule that the members’ assets are fair game. To avoid this, of course, keep your finances separate and always operate your business with integrity.
  2. Self-employment Taxes – Unless your LLC is structured to specifically avoid it, each member will be considered self-employed by the IRS. As a result, each individual will be required to pay self-employment taxes on their federal returns each year.
  3. LLCs Can End – If a member of an LLC leaves due to death, divorce, disinterest, or any other reason, the LLC dissolves and the remaining members are responsible for all of the company’s obligations. If they choose to continue doing business, they’ll have to go through the process of reorganizing all over again. Over time, if things among the members are unstable, this can often turn into a headache.

Options and Tax Implications with LLCs for General Contractors

If you feel like an LLC might be right for your contracting business, here are 2 options and their tax implications:

Single Member LLC

It’s possible to be an LLC all by yourself. Similar to a sole proprietorship, a Single Member LLC (SMLLC) has only one “member”. With this arrangement, you enjoy all the benefits of being a sole proprietor along with the benefits of limited liability that come with being organized as an LLC.

If you are in an industry with a high risk for lawsuits or you have a significant net worth, structuring your company as an SMLLC may be a good idea. This will help avoid putting your personal assets at risk. However, banks will often still expect you to personally guarantee any loans or debts you get involved with on behalf of your business.

As the only member of an SMLLC, you are not considered an employee of the company. You are still seen as the owner. Therefore, your taxes continue to be filed as a self-employed individual. You can use Schedule C just as you would as a sole proprietor.

S Corp

Contractors who organize their company as an SMLLC have the option of choosing to have their business taxed as an S-Corporation, also known as an S subchapter. This is a distinction with the IRS that allows such companies to pass along income, credits, deductions, and losses directly to their shareholders, avoiding corporate taxes. Shareholders report income passed along to them on their individual tax returns.

In this scenario, you, the owner, are also an employee of the company. You can pay yourself (the employee) a reasonable market wage (the IRS won’t allow you to intentionally underpay) and then pass along a share of the profits to yourself (the owner).

Your regular employee wages are taxed normally. However, any profit distributions you give yourself do not have to have any Social Security or Medicare withholdings applied. You only have to pay your regular income tax rate on them.

If your business is generating a significant amount of profit each year, you can realize some pretty big savings.

As with all important business decisions, it’s best to get the advice of experienced professionals first. When you’re ready to get started setting up your business, give us a call at (731) 668-4482 or schedule a call with our team of business experts!

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