Project management is critical for many types of businesses, and companies often outsource the task to project management companies. If you’re starting a project management business or are already running one but have not formed a business entity, you may want to consider forming a limited liability company (LLC).
An LLC offers many benefits for project management businesses or any type of business. Here we will cover the advantages that an LLC can offer, but first, we’ll explain a few things.
What Is an LLC?
An LLC is a business entity formed by registering with your state. LLC owners are called members and have the benefit of personal liability protection as well as other benefits.
An LLC is easily formed by filing a document, usually called the articles of organization, with your state. In most states, you can file the document online on the Secretary of State’s website. With this comprehensive guide to forming your LLC, you’ll have all the information you need to make informed decisions about your business.
What Is My Company if I Don’t Form a Business Entity?
If you’re running your business on your own and have not formed a business entity, you’re operating by default as a sole proprietorship. In a sole proprietorship, you and the business are one and the same. The IRS considers your business a disregarded entity for tax purposes, and your business income is reported on your personal tax return.
If you’re running the business with a partner or partners, you’re operating as a general partnership. You and your partners are the business. Business income is reported on the personal tax returns of the partners based on their ownership percentages.
Benefits of an LLC
An LLC offers many benefits for its members that sole proprietorships and general partnerships do not have.
Personal Liability Protection
As stated above, if you’re operating as a sole proprietorship or general partnership, you, or you and your partners, and the business are one and the same. This means that the obligations of the business are yours as owners.
The issue with that comes if your business cannot pay its debts or is sued. Because the obligations of the business are yours, you are personally liable for the debts or anything claimed in a lawsuit. This puts your personal assets, including your home, at risk.
An LLC, on the other hand, is a separate entity from its members and has its own assets and debts. This means that you are not personally liable if the business cannot pay its debts or is sued, so your personal assets are protected.
The personal liability protection is one of the main reasons that entrepreneurs choose to form an LLC. With a project management company, you may not think that you’ll ever make a mistake that brings a lawsuit, but the risk exists.
Flexible Tax Options
An LLC, by default, is a pass-through entity, meaning that the profits and losses of the business are passed through to the members. If your LLC has only one member, you’re taxed as a sole proprietorship and considered a disregarded entity by the IRS.
If your LLC has more than one member, you’re taxed as a general partnership.
In either case, profits and losses are reported on your personal tax return or returns and are taxed at personal tax rates.
However, the owners of pass-through entities including LLCs, sole proprietorships, and general partnerships are subject to self-employment taxes, the rate for which is 15.3% as of 2022.
Here’s where the benefit of having an LLC comes in. Members of an LLC can elect to have the LLC taxed as a corporation, and corporation shareholders are not subject to self-employment taxes.
Corporation tax status, though, does make managing the business a bit more complex, and can add additional expenses. For a corporation tax status to be of benefit to you, the self-employment tax savings must exceed the additional expenses.
The tax status choice is best made with the help of a tax advisor who can do the calculations required.
Profit Sharing and Distribution Options
In most types of companies, including general partnerships, profits and distributions are allocated based on the percentages of the owners’ capital contributions.
In an LLC, on the other hand, profits and distributions can be allocated in any way that the members agree upon.
For example, if you and one other member each contributed $20,000 to start the business, perhaps you are the one managing the business on a day-to-day basis. This means that instead of having 50-50 ownership and a 50-50 profit distribution allocation, you could be a 70% owner and receive 70% of profit distributions, or any other allocation that you choose.
You and the member just have to agree and then specify the structure in an operating agreement. An operating agreement is not required in most states, but clearly it’s critical, particularly if your LLC has two or more members.
The operating agreement defines ownership percentages, how profits are distributed, how disputes are resolved, and much more.
It’s important to have an attorney involved in drawing up your operating agreement so that the interests of all parties are protected.
Simplicity and Management Control
While you could choose to form a corporation instead of an LLC, a corporation is more difficult to form and manage. A corporation comes with many administrative requirements including having a board of directors and following annual meeting and reporting rules.
An LLC is simple to form and does not come with such requirements. You have full control over how the LLC is managed.
The members can manage the LLC, making it a member-managed LLC, or you can hire outside managers, making it a manager-managed LLC. The choice is completely up to you and the other members.
The Credibility Factor
When you have an officially registered business entity, your clients’ perceptions of your business may be different. With LLC in your business name, you appear to be more of an authentic company. It doesn’t seem important, but it can really give the impression that you’re more of a professional project manager.
In Closing
Clearly, an LLC offers many benefits, of which personal liability protection is arguably the most important. To find out if it’s the best option for your project management business, it’s wise to consult with your tax advisor and attorney. The choice can affect the future of your business.
