An LLC (limited liability company) provides more flexibility than a corporation, and more robust liability protection than a sole proprietorship.
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Updated on: July 15, 2024 · 14 min read
An LLC, or "limited liability company," is a business structure that protects business owners from personal liability for the limited liability company's business debts. LLCs as a business structure are very popular, but how do you know if it's your right choice? Let's explore all that you need to know in our definitive LLC guide.
A limited liability company is a business designation that limits the personal responsibility of its owners for their company's debts and liabilities while also allowing them to avoid the double taxation often associated with corporations. Instead, the responsibility falls on the LLC, meaning the firm is its legal entity.
In bankruptcy or a legal dispute with the business, LLCs protect owners' personal assets like bank accounts, homes, and cars. Thanks to these LLC advantages, they're popular among many new business owners of small and medium-sized businesses.
LLCs are so popular because they limit the personal liability of their members and owners, protecting their personal assets. LLCs are designed to keep their owner's assets separate from their business assets so that in the case of bankruptcy or lawsuit, the personal assets and personal income of the LLC's owners and members are protected from business liability.
LLCs offer a simple, adaptable corporate structure perfect for businesses of any size. More importantly, they give protection from liability and control over finances. That said, they suit some business models more than others. So, before creating an LLC, you should weigh the pros and cons.
While personal asset protection is one of an LLC's most attractive features, other benefits come into play, such as:
Despite the benefits of LLCs, they come with drawbacks, too. Owners need to weigh operational costs, registration, and legal compliance against an LLC's other tax advantages and disadvantages. The main disadvantages include:
The articles of organization are legal documents that are filed with the Secretary of State when you form your LLC. The articles of organization outline the basics of your LLC. Articles of organization include:
Articles of organization are also used to set up how the new company will be run, including the rights, powers, duties, liabilities, and other obligations each LLC member has. Having the guidelines in an official document can help your LLC run smoothly as your business moves forward.
LLCs include single-member, multimember, multi-member, -managed, manager-managed, and PLLCs—professional limited liability companies.
The individuals who own and run LLCs are called members. Limited liability companies' members invest capital, or membership interest, to claim a stake in the business. The number of members involved and their managerial approach determines the type of LLC they run. We've outlined the main LLC types below to break down the differences in limited liability companies.
If you're the sole owner of an LLC, it's a single-member entity. Single-member firms benefit from low startup costs and minimal paperwork compared to other LLCs. However, you are held personally responsible for legal compliance, debt payoffs, and tax filing.
An LLC with more than one member is known as a multiple-member or LLC. All members must sign off on the firm's written operating agreement to run legally. Besides that, setting up this type of LLC is similar to its single-member counterpart.
An LLC is member-managed when members manage the business themselves. These members can act on the company's behalf so long as they adhere to the operating agreement.
Manager-managed LLCs involve members hiring managers to run operations. This allows owners to place leadership decisions in trusted staff's hands. The details of a manager-managed corporate structure should go in the operating agreement.
A professional limited liability company runs like other LLCs but focuses on certain professions. PLLCs form when states with regulatory board licenses on specific professional services or trades prevent these professionals from forming normal LLCs. In these cases, accountants, legal advisers, or medical workers often work under PLLCs instead.
The most common alternatives to an LLC are corporations, partnerships, and sole proprietorships. Each business structure presents benefits and drawbacks over LLCs. Here's a brief explanation of other kinds of business structures.
With sole proprietorships, the business owner—or sole proprietor—has total control over the business and benefits from pass-through taxation. Its biggest drawback is unlimited personal liability. The sole proprietor is completely liable for all the company debts.
Partnerships include two or more owners who agree to share a jointly owned business' assets, liabilities, and legal burdens. Partnerships place no caps on business liabilities. As a result, owners can have their assets seized to pay off debts. Unlike an LLC, partnerships aren't legal entities in themselves.
A corporation is a more formal business entity involving bureaucracy, ongoing paperwork, and stricter reporting than an LLC. There are shareholders instead of members, and stock is issued to raise money. In addition, you must elect a board of directors to lead operations. Finally, even though LLCs aren't corporations, they can still elect to be taxed and file taxes as one.
S corporations are a form of business entity that uses pass-through taxation to pass their income, losses, credits, and deductions to shareholders. As a result, the S corporation shareholders report their income and losses on their owners' personal income and personal tax returns at individual tax rates instead of the corporate tax rate. The S corporation business entity also avoids double taxation on corporate earnings. An S corp has some specific advantages.
While LLCs shield members from liability, they also must adhere to certain legal guidelines. State and federal law compliance involves research, planning, and careful leadership. Your operating agreement needs to address these concerns and provide a roadmap when legal questions arise.
Generally, an LLC has fewer entity-related responsibilities than a corporation. However, LLCs are legally obligated to create an operating agreement that details:
Many states require LLCs to file a report yearly, which includes a filing fee. These reports detail their current business locations, activities in the state, and any changes in their current members and managers. Filing the report and paying the related filing fees keep management compliant with state law.
Businesses, including LLCs, look for inventors when capital is low. Operating agreements outline the terms for adding capital contributions to the owners of an LLC.
Some LLCs allow new members if they invest significantly in the company. However, some LLCs prefer to keep the current leadership. In this case, the operating agreement will outline a process for drawing more capital from existing members.
LLC owners and members decide how owners can transfer or withdraw their interests. Control over business interests ensures that all members approve of new additions and departures. For control over your members, answer these questions in your operating agreement:
If members can withdraw their capital from the LLC anytime, the small business owners' personal finances take a hit. However, building a process around the transfer of interest allows you to change members without jeopardizing the company. It will also avoid legal disputes and court fees.
In rare cases, members will choose to dissolve their LLC. First and foremost, the operating agreement should outline a dissolution process. Additionally, it needs to set guidelines in case some members want to dissolve the LLC, and others don't.
Members could avoid facing a legal battle or bidding war for company interests if one owner of the agreement controls this process.
LLCs that operate overseas are called offshore LLCs. Even though you can run an offshore LLC from your home state, there's a catch. Your business must meet the laws and tax guidelines of any country you operate in. Depending on where you do business, LLC laws apply: There may be extra guidelines, costs, or LLC components the U.S. doesn't recognize.
For example, the United Arab Emirates imposes setup fees on LLCs of about $7,000. In this case, forming an LLC abroad is much more expensive. On top of that, you'll need to renew your license each year for about $4,000.
Sometimes, LLCs aren't recognized. South Africa, for example, uses a proprietary limited company (Pty Ltd.). A Pty Ltd. C corp isn't expensive to form and protects shareholders from personal liability. However, they can only have up to 50 shareholders, and Pty Ltd. shares are more difficult to transfer.
Tip: Before doing business abroad, research the costs and guidelines of doing business in another country.
An LLC must qualify to run in any state where it conducts intrastate business. Some states also require qualification if you conduct interstate business from that location.
Registering as a foreign business in other states is similar to registering in your home state. We've included a table summarizing important registration information, including for foreign entities, below.
Different types of LLCs pay taxes through unique forms and channels. Your forms and tax rate depend on the structure of your business and filing decisions. LLCs generally file taxes as a sole proprietorship, partnership, or corporation. LLC taxes and filing statuses fall into three categories:
If your business is a single-owner LLC, the Internal Revenue Service, or IRS, views it similarly to a sole proprietorship for federal tax purposes. That means the LLC doesn't need to file a return with the IRS. However, as the sole owner, you must report all profits and losses when you file your personal taxes with the Internal Revenue Service.
According to the Internal Revenue Code, in order to file taxes, report your operating results by submitting Profit or Loss Form Business (Sole Proprietorship) (Form 1040, Schedule C) with your 1040 personal tax returns.
In the case of a multiple-member LLC, the IRS views your business as a partnership. Therefore, the co-owned LLC doesn't pay income taxes. Instead, each LLC owner pays taxes on their share of the profits on their income tax returns.
File the return on Form 1065, U.S. Return of Partnership Income. Each owner should show their pro-rata share of partnership income, credits, and deductions on Schedule K-1.
Distributive shares refer to each member's share of the LLC's profits. Members must report this sum on their own personal income and tax returns. The IRS reviews each member's tax return to ensure that LLC members report their income correctly.
Single-member and multi-member LLCs can also elect to file taxes as a corporation, which may reduce the amount your LLC owes. LLCs that file as corporations gain access to tax breaks and write-offs other structures can't use.
File Form 1120, U.S. Corporation Income Tax Return. The 1120 is the C corporation income tax return, and there are no flow-through items or flow-through taxation to a 1040 or 1040-SR from a C corporation's federal tax return. If your LLC files as an S corporation, it should file Form 1120-S, U.S. Income Tax Return.
Check out the Internal Revenue Service website for more information on LLC filing methods.
The process of starting an LLC is fairly simple. Although specific requirements vary by state, most LLC formation processes tend to follow these general steps:
If you're in a sole proprietorship or partnership looking to develop your business, you might want to consider forming an LLC. Pivoting to an LLC is perfect for businesses and owners that want:
Now that you better understand the ins and outs of an LLC, you can see why it's a popular structure that may be right for your new business venture. Whether you run a small business or a growing corporation, learning the strengths and weaknesses of your model can help improve operations.
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