10 Common Mistakes LLCs Make (and How to Avoid Them)

Setting up a Limited Liability Company (LLC) is a smart step for small business owners. You’ll be afforded operational flexibility, personal liability protection, and potential tax advantages. But too often, LLC owners make missteps that can create ill-timed legal and financial problems. Here are ten common mistakes LLCs make—and how to avoid them.

1. Co-mingling Personal and Business Finances

When it comes to personal asset protection, an LLC is a great hybrid between a corporate and partnership structure. But the personal liability protection you have only holds firm if you don’t co-mingle personal and business finances. Lawyers often refer to “piercing the corporate veil ” when speaking about corporations. But this concept also applies to LLCs. That means no using the business debit card for groceries and no depositing customer payments into your personal bank account.

Avoid it: Open a separate business bank account in the LLC name and only use it for LLC activity. Pay yourself a regular draw and stop using your business debit card to pay personal expenses.

2. Not Having an Operating Agreement

Even if you are the sole member-owner of the LLC, you should have an operating agreement in place. And it’s even more crucial for multi-member LLCs to avoid future disputes. This internal document outlines many important items, including how your business operates, how profits and losses are distributed, and what happens if you want to add a new member.  

Avoid it: Draft an operating agreement that reflects your goals and structure. And because LLCs are state-governed, it’s a good idea to consult an attorney familiar with the laws of your state to ensure a solid operating agreement.

3. Misclassifying Workers

Hiring independent contractors is tempting because it seems simpler than hiring employees. But simple can equal costly. Misclassifying a worker can lead to tax penalties, back wages, and legal issues. With the recent release of Form 1099-NEC, it’s important to understand when to use this form over the traditional Form 1099-MISC, and when to put these contractors on payroll. The IRS is making a push to impose stiffer penalties for businesses not issuing these forms correctly.

Avoid it: Understand the difference between independent contractors and employees and know what the IRS is looking for in classifying them as such. You can use this checklist as a guide to classifying your contractors. When in doubt, talk to a CPA or employment attorney.

4. Ignoring State Compliance Requirements

Because LLCs are formed and dissolved at the state level, every state has different rules for them. Local jurisdictions, such as in Kentucky, also impose local filing requirements. This includes annual reports, fees, and franchise taxes. Missing a filing deadline can result in late fees, entity suspension, or even dissolution of your LLC.

Avoid it: Put your compliance deadlines on a calendar or work with a professional to help you stay on top of annual filings and fees.

5. Mixing Up Entity Tax Classification Options

You have control over how your LLC is taxed. In CPA-lingo we refer to this as “check-the-box regulations”. If you do nothing, the IRS will tax your single-member LLC as a sole proprietorship. Or if you are a multi-member LLC, the IRS will tax your LLC as a partnership. But did you know that you can elect to be taxed as an S corporation or C corporation? Many LLC owners make the wrong choice—or never make one at all. This often results in lost tax planning opportunities that benefit you, the owner.

Avoid it: Talk to a CPA about the tax classification that best fits your income level, business structure, and goals. The S corporation election can save on self-employment taxes—but it’s not right for everyone.

6. Taking Distributions Without Considering Taxes

LLC owners often take distributions without setting aside enough for taxes, especially if they're not paying estimated taxes quarterly. It’s also important to know when you should be taking guaranteed payments instead of distributions but understand that both need your focus on setting aside sufficient amounts for quarterly estimated tax payments.

Avoid it: Know your tax obligations. Get into the habit of setting aside a percentage of your income each month to ensure your taxes are paid timely and adequately each quarter. Use your CPA to calculate safe harbor estimates and avoid surprises and penalties at tax time.

7. Not Documenting Major Decisions

Many LLCs, especially single-member ones, operate informally. But failing to document major business decisions—like taking on debt, buying assets, or adding members—can be risky. Disputes, legal challenges, and even loss of legal protection can be unintended outcomes of keeping poor records.

Avoid it: Keep written records of significant decisions, even if it’s just in a simple company minutes log or shared folder.

8. Overpaying for DIY Legal and Tax Services

Online formation services promise quick and cheap LLC setup. But they don’t offer tailored advice—and that can cost you more later. Submitting fill-in blank documents isn’t a substitute for legal or tax services. Also, there is often confusion as to which additional forms they are filing for you. I have had dozens of new clients come my way thinking the online formation service filed their S-election form with the IRS. When the first tax return was e-filed, it was rejected because the S-election was never actually filed. This is a time-consuming and expensive fix, but all too common occurrence.

Avoid it: Use online tools wisely but consult with a CPA or attorney before making major legal or tax decisions. Getting it right the first time saves money in the long run.

9. Overlooking Insurance Needs

An LLC limits personal liability, but it doesn’t replace business insurance. You can still be sued or lose assets if you’re not properly covered. Know the type of insurances you need. Do you have a brick-and-mortar store? Do you own the building? Do you have employees? Do you offer professional services? Are you selling online? Providing IT services?

Avoid it: Depending on your industry, consider general liability, professional liability, and cyber insurance. A good broker can help you find what you need.

10. Not Planning for Growth or Exit

Many LLC owners focus on the day-to-day and ignore long-term planning. But what happens if you want to bring on a partner, sell the business, or retire? Having an idea of your exit strategy is good proactive planning that will allow for risk reduction, greater clarity, and maximizing an ending payout.

Avoid it: Have a basic business succession or exit plan in place. Even a simple strategy makes transitions smoother and protects your hard work.

Final Thoughts

LLCs are powerful tools—but only when used wisely. Avoiding these common mistakes can keep your business compliant, profitable, and protected. If you’re unsure where your LLC stands, now is a great time to do a quick checkup or consult a trusted advisor.