What Is a Limited Liability Company (LLC)?

What does LLC mean? LLC stands for Limited Liability Company. Many small business owners choose to operate as an LLC because it protects them from being personally liable. This means business creditors cannot go after their personal assets such as their houses or vehicles. LLCs are relatively simple to set up and also offer tax advantages and other benefits. Wondering if an LLC might be the right business structure for you? Keep reading.

How Does an LLC Work?

When owners organize an LLC, they become its “members.” They enjoy the same liability protections as corporations but with less complexity and fewer operating expenses. For that reason, sole proprietors — professionals who operate without distinction between themselves and their business — may want to consider setting up an LLC. Beyond sole proprietors, some of the most common companies to choose the LLC business structure are commercial property and rental companies. While many LLCs are small businesses, there are plenty of large multi-member LLCs, including IBM and Pepsi-Cola.

Advantages of an LLC

We’ve already mentioned a few benefits for business entities that choose to be an LLC, but let’s go deeper into the details.

Liability Protections

By forming an LLC, members protect themselves from personal liability related to any lawsuits or debts incurred by the LLC. While an LLC’s creditors or those who file lawsuits against it can collect from the LLC’s assets, like its business bank account, they are unable to do so from members’ personal assets. This means members’ personal bank accounts and personal property enjoy liability protections and cannot be seized related to an LLC’s activities.

Easy to Start Up and Run

Compared with other business structures, LLCs are relatively easy to set up. Many small business owners do the paperwork themselves, though some may seek legal advice, especially those setting up a multi-member LLC. LLC members will find that running an LLC is fairly straightforward. Unlike corporations, LLCs do not require directors or officers, nor do they need formal shareholder or board meetings. Plus, most states only require simple annual reports from LLCs based within their borders.

Flexibility

We’ll get into more details below, but the LLC business structure provides flexibility on several fronts, including management, ownership and personal taxes. When it comes to the number of members an LLC has, there is no minimum nor maximum. Members can either manage their LLC themselves or designate an outside manager to sell their products and services at their business, and they get to choose how they want to be taxed (more on that further down).

Disadvantages of an LLC

While many find mostly upsides to starting an LLC, there can also be some downsides depending on how you see the future of your business. So, it’s good to know these upfront.

Transfer of Ownership

LLCs are fully owned by their members. They do not, therefore, have transferable shares. This can make selling or transferring ownership to a smaller number of members more complicated for members of an LLC.

Lower Investor Appeal

Business owners who want to attract investors may want to consider a corporate business structure over an LLC, especially if they need a large investment to start their business. Why? Corporations can issue stock in exchange for invested funds, which is a much simpler process than granting ownership interests in an LLC.

Must Immediately Recognize Profits

LLCs are not subject to double taxation. While this is generally seen as a benefit, it also means that members must include their LLC’s profit (taken as distributions) in their personal income when preparing their taxes. These distributions are seen as separate personal income beyond whatever a member might be paid by their LLC as a salaried W-2 employee. Other business structures, like C corporations, do not have to distribute profits immediately.

Cost of an LLC

While LLCs are relatively inexpensive to form and run, they do cost more than sole proprietorships and are subject to payroll taxes for employees. Taxes and fees vary by state. They can include state certification filing fees as well as charges from legal and accounting professionals should you seek help with preparing articles of organization or an operating agreement. Some states include additional tax fees, such as California’s $800 franchise tax fee, due annually from LLCs. The lowest-cost state when it comes to LLC filing fees is Kentucky at $40 with $15 for each following year. Massachusetts charges the highest initial filing fee at $500, while California has the highest annual fees after the initial year with $800 due annually and $20 biennially.

How to Start an LLC

Forming an LLC is relatively simple. You can set up an LLC by following the steps below.

Choose a Name

First, select a name for your LLC. Before registering the name in the state where you plan to do business, check available online directories, the secretary of state’s office for your state, and/or your county clerk’s office to make sure the name is available. It’s also wise to do an online search to ensure your name isn’t too close to another business’ name and that you’re not inadvertently associating your business with a meaning or movement that doesn’t align with your brand. Finally, if you may sell your business later, avoid using your personal name for the business.

Pick a Registered Agent

Your registered agent is the person who receives official mail and correspondence for the LLC, so you’ll need their name and address. This can either be yourself, another member of your LLC or a third-party registered agent service.

File Articles of Organization

These are the legal documents you must file with your secretary of state to make your LLC a legal entity. To file, you’ll need a business name, an address for your principal place of business and the management type.

Create an Operating Agreement for Your LLC

While not every state requires an LLC operating agreement, it’s a good idea for multiple-member LLCs and single-member LLC owners who want additional protection against personal liability. This legal document often includes an ownership breakdown, management structure, duties/powers of managers and members, member voting rights, and information about how profits and losses are distributed.

How to Obtain an EIN

As an individual, you have a social security number. For your business, you’ll need an Employer Identification Number (EIN). The IRS uses a nine-digit EIN to identify your business, so you can apply for your EIN directly to the IRS without any fees.

Limited Liability Company (LLC) Taxes

Wondering about how to handle LLC taxes? Here are some details.

Double Taxation

LLCs are not categorized as separate taxpayers, so they don’t pay taxes on profits (just on employee payroll). This means double taxation does not apply to LLCs. However, members must claim profits on their own personal income taxes.

Pass-Through Taxation

Because LLCs don’t pay corporate tax, members must report the profits on their personal tax returns. They essentially pay a self-employment tax, often via quarterly estimated tax payments. This is called pass-through taxation and is the reason why double taxation doesn’t apply to LLCs.

Self Employment Tax

LLC members must pay self-employment taxes on their personal share of the LLC profits.

LLC FAQs

Below are commonly asked questions — and their answers — about LLCs.

What’s the Difference Between an LLC and a Sole Proprietorship?

LLCs are entities that provide legal separation between the members (owners) and the business. Sole proprietorships do not. So, if the business gets sued, then the owner may have to pay out from their personal assets.

What’s the Difference Between an LLC and an S Corporation?

While not all do, LLCs have the option to convert to an S corporation (S corp) rather than the default C corporation. Members must simply file an additional Form 2553 with the IRS. As an S corp, they’ll no longer have to pay taxes twice (double taxation). There are some limitations, however, such as there can only be up to 100 shareholders, and none can be corporations for foreigners.

How Many Owners Can an LLC Have?

An LLC can have infinite owners (members). There is no maximum.

How Much Does it Cost to Form an LLC?

The cost of forming an LLC varies by state and so do the annual fees. Check out this state-by-state comparison and a rundown of typical fees. Of course, it’s wise to check the resources provided by your state’s business filing office, typically the secretary of state, for the most up-to-date information.