An LLC, or limited liability company, provides business operators the protections usually only afforded to corporations and the simplicity often only available to sole proprietorships. LLCs offer legal protection of personal assets and pass-through taxation through a separate entity that isn’t limited to a specific number of shareholders or heavy regulation.
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What Is an LLC?
A limited liability company, or LLC, is a U.S. legal entity used to own, operate and protect a business. LLCs provide the same legal and financial protections corporations do but can be simpler to operate.
What Are the Benefits of an LLC?
Other common forms of businesses, including corporations, general partnerships and sole proprietorships, offer various benefits, but the LLC entity combines the advantages of each structure.
Asset Protection
The main advantage to an LLC is in the name: limited liability protection. Owners’ personal assets can be protected from business debts and lawsuits against the business when an owner uses an LLC to do business. An LLC can have one owner (known as a “member”) or many members. Businesses as well as individuals can be members of an LLC.
Taxation Options
LLCs also provide more flexibility than other business types as to how taxation functions. LLCs are automatically taxed as either a sole proprietorship or partnership, depending on whether there’s one member or multiple members. Members report their share of business income and expenses on their personal tax return and pay personal income tax on profits. Members who work in the business are considered self-employed and also must pay self-employment (Medicare and Social Security) taxes on their share of the profits.
If the entity wishes not to be taxed as a sole-proprietorship or partnership, the LLC can also elect to be taxed as an S-corp or C-corp. Corporate taxation allows LLC owners to be paid as company employees, participate in company benefit programs and potentially save on taxes. A C-corp pays corporate tax and its owners pay tax on distributions they receive. An S corp is a pass-through entity–it doesn’t pay corporate tax but each owner pays personal income tax on their share of the company’s profits. But not all LLCs qualify for S Corp. taxation–they must meet IRS requirements.
Versatility
LLCs are not required to have annual shareholder meetings or maintain a board of directors, nor are they bound by the administrative requirements often seen with corporations. Instead, an LLC’s members may organize how they like: Members or managers may manage the business’s operations as they see fit.
Legal Name and Credibility
State law usually doesn’t allow you to form a new business with the same name as an existing one. When you form an LLC, you gain the exclusive right to use your name as a business entity name in your state, and you also create a public record of your use of the name. The LLC moniker at the end of a company’s name can also lend credibility to a small business.
Profit Sharing Flexibility
One advantage a multi-member LLC has is the ability for members to decide how to share profits. Corporations issue dividends on stock according to the number of shares owned, and partnerships normally split profits among partners, but an LLC can elect how its profits are shared, not shared or otherwise distributed. Beware, however, that IRS rules about special allocation of profits may require profit sharing to reflect ownership percentages or legitimate economic need or circumstance—and not be some attempt to avoid paying taxes.
What Are the Disadvantages of an LLC?
The first major disadvantage to an LLC, especially for smaller businesses, is cost.
LLCs are formed and registered at the state level, so the process—and the associated fees—can vary slightly from place to place. Setting up an LLC may cost a few hundred dollars. Many states require LLCs to file annual reports and pay annual fees and taxes that can vary between $10 and $800 or more.
While LLCs have “members” who own the business, an LLC does not issue stock in the same way a corporation does. Membership in an LLC isn’t as easy to transfer from one party to another as corporate stock is. In the absence of a contrary provision in an LLC’s operating agreement, some states require an LLC to be dissolved any time there is a change in ownership. Because of this, many businesses find a corporation’s structure more friendly to outside investment. LLCs offer serious flexibility when it comes to how a business can organize, manage and run its affairs, but those businesses with major outside investment requirements may find another structure more conducive to those forms of funding.
Should I Form an LLC?
Forming an LLC offers major benefits for most small to medium business owners. Registering and operating as an LLC will provide business owners legal protection for personal assets, credibility and a long list of other advantages usually only found spread throughout a number of other business structures.
LLC Formation Costs
LLC registration and filing costs vary by state, as do taxes levied on LLCs. Hiring a lawyer to form an LLC can often be pricey, but may be necessary for those businesses with more complicated structures or many members. In most states, it costs between $50 and $200 to start an LLC, but a few states have fees as high as $500. You’ll have additional costs if you hire someone to help you with the process or act as your registered agent.
LLC State Guides
Frequently Asked Questions About LLCs
What is a foreign limited liability company?
A foreign LLC simply refers to one that operates in a different state than the one it was formed in. This is especially common for businesses located in cities close to state lines, where they may want to expand across the border. Operating in multiple states may make the LLC obligated to register documentation, pay taxes, and obtain other licenses in each state. And since each state has its own laws for governing LLCs, the business must make sure they stay in compliance with all of them.
Do I need to hire a lawyer to register an LLC?
No. Filing and registering an LLC with any given state does not require an attorney. For more complicated business structures and those who want to ensure no mistakes are made, hiring a lawyer may be advisable. Generally, however, forming an LLC does not specifically require hiring a lawyer. If you do want legal assistance at an affordable rate, consider using one of the best LLC services.
Is an LLC the same thing as a corporation?
An LLC offers some benefits of a corporation and vice versa, but an LLC and a corporation are two different business entities and are not the same thing. Learn more about LLCs vs corporations to determine which structure is best for your business.
What kind of tax flexibility does an LLC provide?
LLCs can be taxed as sole proprietorships, partnerships, C corporations or S corporations. This choice allows members of an LLC to minimize their tax burden.
Is it possible to set up an LLC for free?
While the cost to register an LLC varies by state, there is a fee to register in every state. So, while there are some companies that advertise “free” LLC formation, what this really means is that the company will fill out the LLC paperwork for you for free. But again, you will still be responsible for the state’s filing fee.
Is an LLC different from having liability insurance?
An LLC is not a commercial liability insurance policy and does not offer the same benefits. While an LLC protects you from personal liability from most business debts, liability insurance can protect you in the event someone claims your business caused an injury or property damage. Liability insurance for a business is also advisable in addition to the legal protections personal assets may receive from an LLC business structure.
