A limited liability company (LLC) is a legal status granted to businesses. This designation can relieve the business owners of personal responsibility for their company's debts or liabilities and establishes the business as its own legal entity.
In the event of a bankruptcy or a legal dispute with the business, the owner's personal assets like bank accounts, homes, and cars can't typically be viewed as assets of the company.
An LLC is owned by one or more individuals who are referred to as "members." If you're the sole owner, it's a single-member LLC. More than one owner is known as a multi-member LLC.
What Are the Benefits of an LLC?
While personal asset protection is one of an LLC's most attractive features, there are other benefits associated with this business structure.
- Ease in filing taxes. Single-member LLCs are often taxed as sole proprietorships, and profits are only taxed once. As the owner, the tax liability "passes through" to your personal tax return, known as pass-through taxation. To file taxes, you report your operating results, including profit or loss, by submitting Profit or Loss Form Business (Sole Proprietorship) (Form 1040, Schedule C) with your personal 1040 tax return. Single-member LLCs can also elect to be taxed as corporations.
- Little bureaucracy and red tape. An LLC is fairly easy to maintain and has fewer formal requirements than a corporation.
- No other business in your state can use your LLC name. This occurs after you register your LLC, and it's a real advantage toward protecting your brand.
How Does an LLC Compare to other Business Structures?
A corporation is more formal, involving more bureaucracy, ongoing paperwork, and stricter reporting than an LLC. There are shareholders instead of members, and stock is issued to raise money. You must elect a board of directors.
With a sole proprietorship, the owner has total control over the business and also benefits from pass-through taxation. But the biggest drawback is unlimited personal liability. The owner is solely liable for all the debts of the business.
What Responsibilities Come With LLC Management?
Generally, an LLC has fewer entity-related responsibilities than a corporation. However, most LLCs are legally obligated to create an operating agreement that details how the company's members, managers, and officers conduct business and identifies who's responsible for what.
Many states also require an LLC to file a report every year—or every two years—that updates their current business locations and activities in the state, and any changes in their current members and managers. There is often a fee associated with this report submission.
How Do LLC Taxes Work?
If your business is a single-owner LLC, the IRS views it in the same way it views a sole proprietorship for tax purposes. That means the LLC itself doesn't need to file a return with the IRS. As the sole owner, however, you must report all profits and losses when you file your personal taxes.
In the case of a multi-owner LLC, the IRS views your business as a partnership. The co-owned LLC itself doesn't pay income taxes. Instead, each of the LLC owners pay taxes on their share of the profits on their own personal income tax returns.
Each member's share of the profits and losses is called a distributive share and the IRS expects you to report it each year, even if your LLC has not distributed your share. The multi-owner LLC must also file a Form 1065 with the IRS. This return reports on the members' shares and the IRS reviews it to make sure the LLC members are reporting their income correctly.
Single-member and multi-member LLCs can also elect to be tax as a corporation, which may reduce the amount your LLC is taxed.
How Do I Start an LLC
The process for starting an LLC is fairly simple. It can vary by state, but generally, these are the steps.
- Make sure your current business name isn't being used by any other business in your state. Your state will let you know if there's an issue. And often, you're required to add "LLC" or "Limited Liability Company" to your name.
- File Articles of Organization. This basic document identifies your business name, address, and other entity information. Your state may already have a form that's easy to fill out.
- Identify a Registered Agent to represent your LLC. You can appoint a third-party business or self-designate to receive any legal documents in a lawsuit.
- Pay your state's required fees. Initial filing fees vary by state, and an annual fee isn't unheard of, either.
- Some states require a notice of intent to create an LLC. It's as simple as publishing a notice in your local newspaper announcing your intent. The newspaper staff can easily guide you in what to do. You may also need to file an affidavit of publication with your state.
- Create an LLC operating agreement. An operating agreement is required by most states and helps avoid issues down the road among members of an LLC.
If you're in a sole proprietorship or partnership and want more protection from individual liability for business debts and lawsuits, you might want to consider forming an LLC. Now that you better understand the ins and outs of an LLC, you can see why it's a popular business structure that may be right for your new business venture.