A limited liability company (LLC) combines elements of a partnership, sole proprietorship, and a corporation to ensure that the company owners are not personally liable for their company's debts or liabilities.
What Does Limited Liability Mean?
Limited liability means that its owners, also called members, are usually not personally responsible for the LLC’s debts and lawsuits.
If an LLC files for bankruptcy, the members do not have to use personal money to pay the company’s debts. If the LLC faces a lawsuit, the members do not risk losing their home to cover a settlement.
In the eyes of the Internal Revenue Service (IRS), however, LLC taxes usually resemble a sole proprietorship or partnership. The LLC does not pay income taxes itself. Instead, the owners list business profits and losses on their personal tax returns. The LLC can choose to tax itself as a corporation. To do so, it must follow corporation tax law and filing requirements.
LLC owners must file formal documents with their state, pay a filing fee and comply with other regulations before hanging out the shingle. In some states, LLCs have to pay an additional franchise tax. Partnerships and sole proprietors don’t face the same level of paperwork and fees. Unlike a corporation, an LLC does not issue stock and is not required to hold annual meetings or keep written meeting minutes.
Do You Need an LLC?
If your business faces a reasonable risk of lawsuits or if business debt is a possibility, you may want to consider an LLC to protect your personal assets. For example, if you open an ice cream shop, your liability insurance may not fully protect you if a customer sues after he slips on melted Rocky Road.
If you are a solo entrepreneur, you can still form an LLC. It only takes one owner to form an LLC.
However, if you run a banking, trust, or insurance industry businesses, you cannot form an LLC. Some states also prohibit architects, accountants, doctors and licensed healthcare workers from forming LLCs.
How to Start an LLC
In most states, all you need to do is file Articles of Organization with your Secretary of State and pay the required filing fee. The Articles of Organization form requires only basic information. If you know your business name, location and the names and addresses of the owner/members and registered agent—the person that accepts legal papers on the LLC’s behalf—you can start your business. No lawyer needed.
To make the process even easier, most states will let you do file the articles of organization online or by mail. A few states require businesses to publish an intention to form an LLC in the local newspaper.
Although it’s not required, an LLC Operating Agreement comes highly recommended. An operating agreement allows you to structure the financial and working relationships with co-owners to suit your business’s needs. The operating agreement should spell out how members will divide profits, make business decisions and handle the exit and arrival of members. The operating agreement ensures that the business will operate by its own rules in these situations, rather than the default rules of the state.
In the event of a lawsuit, the operating agreement shows the court that you have a legitimate, organized business. This protects your assets, because without it, the court may consider your business a sole proprietorship.
How to Convert to an LLC
If you already have a sole proprietorship or partnership, you can convert to an LLC anytime. The tax structure does not change, but you will have some paperwork to wrestle with. In some states, a business owner only has to fill out a certificate of conversion. Other states require Articles of Organization just like starting an LLC from scratch. In all states, you will have to transfer your federal and state employer identification numbers, sales tax permit, business license and any professional licenses to the name of your new LLC.
Although the LLC definition involves many levels of consideration, protection of personal assets is key. An easy way to define LLC is to think of the flexibility of a sole proprietorship or partnership combined with the protection of a corporation. For the right business, this could be the best of both worlds.