Why an LLC can be so useful for individuals

After writing about Facebook (FB) founder and CEO Mark Zuckerberg's announcement that he would donate almost his entire holdings of Facebook stock to charity, I heard from lots of readers wanting to know more about the legal structure Zuckerberg is using for his Chan Zuckerberg Initiative.

That structure is called a limited liability company, or LLC. I often suggest to people who are starting a business to form it as an LLC. I also suggest using an LLC to own certain types of property, such as a large tract of land, a special vacation home or a rental property.

That's not because of the tax benefits. An LLC is simply a pass-through entity, with little or no tax benefits. Instead, the most significant benefit is the legal liability protection gained by using an LLC.

It shields your personal assets from the liabilities of the business. This means if your LLC has claims from customers, liabilities or disputed debts, parties with claims can't reach your personal property. The exception is if you act personally (not as an LLC member) or sign a personal guarantee on a loan to your business. So, an LLC provides legal protection of your assets in much the same way as a corporate structure.

A single-member LLC is considered a sole proprietorship for tax purposes. This means individuals who own a single-member LLC will report the income, expenses and net profit from the LLC activities on Schedule C of their tax return. Single-member LLCs aren't required to file a tax return for the LLC entity.

When an LLC has more than one member, it's treated as a partnership LLC, which is required to file a tax return, a Form 1065, U.S. Return of Partnership Income. The Form 1065 allocates the deductions and income to each of the LLC members according to their percentage of membership. This avoids the double taxation that's a problem with corporations. Corporations pay taxes on their income, and shareholders also pay taxes when the corporation's profits are distributed to them in the form of dividends.

To create an LLC, you'll need to file the proper documents with the appropriate state agency and pay filing fees. You'll also need to advertise the existence of the LLC in a few local business journals and obtain an Affidavit of Publication.

It's not a good idea to use your name as the name of an LLC, unless you're in a professional practice such as law or accounting. If something goes wrong (litigation, bankruptcy, etc.) or you want to discontinue the business, you'll be glad you didn't have your name on the entity.

  • Ray Martin

    View all articles by Ray Martin on CBS MoneyWatch»
    Ray Martin has been a practicing financial advisor since 1986, providing financial guidance and advice to individuals. He has appeared regularly as a contributor on the CBS Early Show, CBS NewsPath, as a columnist on CBS Moneywatch.com and on NBC-TV's morning newscast TODAY. He has also appeared on the Oprah Winfrey Show and is the author of two books.