A limited liability company, or LLC, is a type of business structure that offers the liability protection of a corporation with more flexibility in the way the business is managed and taxed. Because of this legal and tax flexibility, LLCs are a popular choice for small businesses.
A limited liability company, or LLC, is a type of business entity authorized under state law in all 50 states. Unlike sole proprietorships and general partnerships, LLCs offer personal liability protection for their owners. LLCs typically involve less paperwork and recordkeeping than corporations, with more flexibility in the way they are managed and taxed.
What are 3 characteristics of an LLC?
An LLC is characterized by:
- Limited personal liability protection for owners
- Flexible management structure
- Ability to be taxed as a sole proprietorship, partnership, or corporation
An LLC's owners are called “members." An owner's stake in the company is known as a “membership interest." An LLC can have one member or multiple members.
How is an LLC managed?
An LLC can be member-managed, or one or more managers can manage it. An LLC with multiple members who are passive investors is more likely to have a manager. A small LLC with just a few members who are active in the business is more likely to be member-managed.
LLCs are flexible in the way management responsibilities are divided, and member-managers don't have to use traditional corporate titles like “president" and “treasurer." This flexibility in management structure is one of the things that makes LLCs attractive to small businesses.
How does an LLC protect its members' personal assets?
If you operate your business as a sole proprietorship or general partnership, you have unlimited personal liability for your business' debts and obligations. You can also be liable for a partner's wrongdoing, even if you had nothing to do with it.
An LLC protects business owners from personal liability for business debts. This means you may lose the money you have invested in the LLC but that business creditors cannot come after your home, personal bank accounts, and other personal assets. Corporations also provide this type of liability protection.
There are limits, however. You are always liable for your own wrongdoings, such as causing an accident or defrauding customers. This is why it is important to have liability insurance for your business. And if you sign a personal guarantee, you are personally liable for the obligation you have guaranteed.
How is an LLC taxed?
The Internal Revenue Service doesn't have an LLC tax classification for federal income tax purposes. Instead, LLCs are taxed as though they were a different type of business structure.
By default, a single-member LLC is taxed like a sole proprietorship or “disregarded entity." LLC members report business income and expenses on their personal tax returns and pay self-employment tax of 15.3% on that business income, as well as personal income tax.
Multimember LLCs are automatically taxed as partnerships. Like sole proprietorships, partnerships are pass-through tax entities. Partners are considered self-employed and will pay self-employment taxes and personal income taxes on their share of business income.
An LLC can also elect to be taxed as either a C corp or an S corp for federal tax purposes. C corporations pay corporate income tax, and shareholders also pay personal taxes on distributions. This “double taxation" means that smaller LLCs don't usually elect to be taxed as C corporations.
An S corp. is another type of pass-through entity that avoids double taxation and offers potential savings on self-employment taxes because members can be classified as company employees. They'll pay payroll taxes on their reasonable salary, but not on additional company profits. The IRS restricts the kinds of companies that can elect S corp status. Restrictions include having 100 or fewer shareholders and not having foreign or corporate shareholders.
Should my LLC be taxed as an S corp?
“It's not always a good idea," says Anna Ortiz, a Massachusetts CPA and host of "The Growth Advisor Podcast." She says she's seen a troubling number of social media posts claiming that S corp election is ideal for everyone. But there are important caveats.
S corp owners must pay themselves a reasonable salary—what they'd make doing similar work somewhere else—and must pay it on a regular basis. “Paying yourself a reasonable salary means you have to make enough money to support the payroll for yourself," Ortiz says. An S corp that pays all its profits in salary may not save anything in taxes. And it will likely have additional expenses for accounting, tax preparation, and payroll services.
“I'd say if you're consistently making six figures in your business and have the money to pay yourself, you might want to look at the analytics to see if your tax liability is lower" with an S corp," Ortiz says. But she cautions against taking a DIY approach to the issue. A tax professional can assess your potential tax liability and advise you on a reasonable salary, which must be calculated in a certain way consistent with IRS methodology.
What are the benefits of having an LLC?
An LLC has several advantages over other business structures, particularly for small businesses. These include:
- Personal asset protection for business owners
- A more flexible management structure and less paperwork and recordkeeping than a corporation
- The ability to maintain sole proprietorship or partnership pass-through taxation
- The potential to save on self-employment taxes by electing S corp taxation
For many small businesses, the advantages of an LLC often outweigh the cost of forming and maintaining the business.
What is the main disadvantage of a limited liability company?
For all their advantages, there are expenses associated with setting up and running an LLC, and an LLC may not be the right choice for growth-minded startups. Here are three disadvantages of a limited liability company:
- There are costs to form an LLC, including initial filing fees, registered agent fees, and fees to an attorney or LLC formation service.
- You may also pay fees to maintain your LLC. Many states require annual reports and annual fees. If you hire a registered agent, you'll pay a yearly fee for that service. And in some states such as California, LLCs pay a mandatory franchise tax.
- Venture capitalists and other outside investors usually prefer corporations over LLCs because corporations are more standardized, and corporate shares are easier to transfer than LLC memberships.
If you aren't sure whether an LLC is the right choice for your business, get advice from a small business lawyer.
What legal documents do I need to form an LLC business structure?
To create an LLC, articles of organization must be filed with the secretary of state or another state agency that handles business filings. The articles will typically list the name of the LLC, its main business address, its purpose, and duration, whether it is member-managed or manager-managed, and the name and office address of its registered agent. The LLC's registered agent is a state resident or registered agent company that has agreed to accept legal documents on the LLC's behalf.
You can usually file your articles online, and in many states online filing is the preferred method. You'll pay a filing fee when you submit your articles of organization. Filing fees vary by state, and you'll pay more if you request expedited processing.
What state should I form my LLC in?
For simplicity and to save money, most small LLCs should file their paperwork in the state where their business is physically located. If you form your business in another state, you'll also have to register your business in your home state. You'll be responsible for any required fees and annual report filings in both states, and you'll need a registered agent in each state.
If your business has locations in more than one state or you believe out-of-state registration may be advantageous, get legal advice. A lawyer can help you decide where to form your LLC and what out-of-state registrations you'll need.
What is an LLC registered agent?
LLC laws vary slightly from one state to another when it comes to who can serve as a registered agent (sometimes called a “statutory agent" or “resident agent"). But generally, you can act as a registered agent for an LLC if you're a state resident with a physical office address, not just a P.O. Box, and you're at least 18 years old. You can also designate an employee, family member, or friend as an agent. Or you can hire a company that specializes in providing registered agent services.
If your business is ever sued or served with a subpoena or other legal document, the agent is responsible for accepting the document on behalf of your business and promptly forwarding it to the appropriate person at your business. Because legal documents are time-sensitive and failing to respond can have serious consequences, it's important to choose an agent you can trust.
If you act as your own agent, your name and office address are publicly available. You should be available to accept “service of process" during business hours. And you risk being served with a lawsuit in person at your place of business. Because of these issues, some LLC owners hire a registered agent company.
Do I need an LLC operating agreement?
An LLC operating agreement describes the way an LLC will be run, including the rights and responsibilities of the members, ownership percentages, how managers are chosen, how profits will be divided, how decisions will be made, how to admit new members or deal with departing ones, and what contributions the members have made to the LLC.
“You definitely need an operating agreement," Jennifer Braster, a commercial litigation attorney and managing partner at Naylor & Braster in Las Vegas, says. “It's a lot harder to navigate when things go bad [without one]."
The need for an operating agreement isn't always obvious when you're forming your LLC. But most small businesses eventually face thorny issues that are much harder to negotiate without an operating agreement's guidance. These include processes for departing members, requests by passive investors to examine company books, and disputes over the way decisions are made or profits and losses are divided.
The easiest time to negotiate and prepare an LLC's operating agreement is in the startup stage, when members share a common goal for their business venture and conflict is at a minimum. When negotiating the terms of your operating agreement, “if you can, you should each have your own attorney to make sure your interests are being met," Braster says.
Does an LLC have to hold meetings?
An LLC doesn't have to hold meetings of members unless the operating agreement or state law requires them. Braster says she recommends regular meetings in some instances but not others.
For example, if you have a two-member LLC where both of you work in the business and talk to each other every day, you may not need to hold formal meetings. But, Braster says, if you have a two-member LLC and one of you runs the business while the other is behind the scenes, “I would recommend meetings. Then you don't have those allegations of 'I didn't know what was going on.'"
How do I choose an LLC name?
Your LLC name choice will probably be driven by marketing and branding concerns, but there are a few state law requirements to be aware of.
Although state LLC laws vary, you generally can't form an LLC with the same name as another LLC or corporation registered in your state. Almost all states offer a name availability search tool on their business services websites so that you can confirm your chosen name's availability before you file LLC formation paperwork.
Your name must include a designation at the end showing that your company is an LLC. Depending on your state's rules, your company name might end with “limited liability company," “LLC," “limited company," or “Ltd. Co." When deciding between “LLC" vs. “Ltd." for your name's ending, consider which ending sounds better and is more consistent with the brand image you want to project.
What happens after I file paperwork to form an LLC business entity?
The state will review your articles of organization. If everything is in order, the state will issue a certificate showing that your LLC legally exists. This can take anywhere from a few seconds to a few weeks, depending on the state. Expedited processing is available in some states for an additional fee.
Once you have your formation certificate, you can apply for a tax ID number from the Internal Revenue Service and open business bank accounts.
Does an LLC need a federal tax ID number?
Most LLCs need a federal employer identification number, also known as an EIN or FEIN. The FEIN is a nine-digit number issued by the Internal Revenue Service that identifies your LLC for tax purposes. Multimember LLCs and all LLCS that have employees must have a FEIN.
A single-member LLC with no employees may be able to use the member's Social Security number instead. However, many single-member LLCs get an EIN to make it easier to open a business bank account, protect the privacy of the member's personal information, and plan for growth.
You can get an EIN instantly and at no charge on the IRS website. You'll need your EIN to open a bank account, set up payroll, set up state tax accounts, and obtain a seller's permit.
How does limited liability protection work?
When you form an LLC, you create a legal entity separate from the LLC's owners. The LLC can own business assets, have bank accounts, and enter into contracts in its own name. When the owners contribute money or assets to the LLC, those contributions become the LLC's property.
If the LLC cannot pay a debt or obligation, creditors can pursue the LLC's assets, including money the owners put into the LLC. But because the LLC owners are legally separate from the company, their personal assets are protected.
To maintain this liability protection, it's important to have separate bank and credit card accounts for your LLC and keep personal and business finances strictly separate. LLC contracts should be signed by an authorized person on behalf of the LLC, not in their personal capacity.
What is the difference between an LLC and an Ltd. company?
A “limited company" often refers to a European business entity whose owners have limited personal liability. But “limited company" can also be a way of referring to an LLC in the U.S.
Many states allow limited liability company names to end with “limited company," “Ltd. Company," or “Ltd. Co." as an alternative to “limited liability company" or “LLC."
What is a limited liability company example?
Most LLCs are small to medium-size privately owned companies, although there are no restrictions on how large or small an LLC can be. Many small local businesses and independent freelancers establish their businesses as LLCs. Landlords who own multiple rental properties often establish an LLC for each property to avoid risking their entire portfolio if one property runs into trouble.
What is a professional limited liability company?
Some states don't allow licensed professionals such as lawyers, accountants, and architects to form an LLC. Instead, they must form a professional limited liability company, or PLLC. Professional LLCs usually have ownership restrictions, and their formation must be approved by the relevant state licensing board. Professional LLCs have similar liability protections as regular LLCs. Members of professional LLCs remain personally liable for malpractice.
What questions should I ask when setting up an LLC?
When deciding whether to set up an LLC, some questions to ask include:
- Is liability protection important to me? If you operate a business with a partner, the answer to this question should almost always be "yes" because of the potential for you to be liable for your partner's actions.
- Will I have outside investors who will own a stake in the company? If your answer to this question is "yes," get legal advice on the best way to structure your business.
- Can I afford the filing fees and maintenance costs of an LLC?
Once you've decided an LLC is right for you, you'll need to answer a different set of questions:
- What should the name of the LLC be?
- Will the LLC be managed by its members, or will it be managed by a manager?
- Who should serve as the LLC's registered agent?
With these basic questions out of the way, you can focus on defining the roles, responsibilities, and contributions of the members and negotiating an operating agreement.
How much will it cost to form and operate an LLC?
You can expect to pay an initial filing fee when you form your LLC, and in many states you're also responsible for an annual reporting fee. Some states have additional mandatory LLC fees or taxes.
Initial filing fees in most states range from about $50 to $200, although a few states have fees in the $300 to $500 range. You'll pay additional fees to reserve a business name in advance or expedite processing of your articles of organization.
Many states require an LLC annual report or statement of information, which is a short form that ensures your business and registered agent information is up to date. There's typically an annual fee associated with these reports. The fee varies by state, but in many states, it's $100 or less.
Other LLC costs may include:
- State taxes. Some states levy a franchise tax on LLCs. Notably, California has a mandatory minimum franchise tax for all LLCs.
- Business licenses. A few states require LLCs to obtain a statewide business license. In other states, your LLC may need local or industry operating licenses. Fees for these licenses vary by type and location.
- Registered agent fees. If you hire a company to act as your registered agent, you'll pay an annual fee for that service.
- Other business services. Like all businesses, LLCs can expect to pay for business insurance, bookkeeping and payroll, tax preparation, and legal advice throughout the life of the business.
What is the difference between an LLC and LCC?
"LLC" is an abbreviation for limited liability company, a type of business structure that is available in all 50 states. If you create a limited liability company, you'll need to use a business identifier such as "LLC" in your business name. "LCC" is not an acceptable abbreviation for limited liability company.