What is an LLC?
Updated: July 21, 2021|
Updated: July 21, 2021|
If you own a business or are thinking of starting one, choosing a type of business structure is important to meet your business needs and goals. A popular type of business among small business owners and start-up entrepreneurs is an LLC (Limited Liability Company).
Whether you want to start a moving company, a tech start-up, or any small business, an LLC business structure provides various advantages because of its simplicity, flexibility of set-up, and low fees.
This guide will show what an LLC is, show you a brief overview of how they work, and give you what you need to get started with your business.
An LLC, or Limited Liability Company, is a business structure that makes it easy for individuals to start their businesses because of its affordability, uncomplicated maintenance, and versatile tax options.
LLCs provide personal asset protection like a corporation and pass-through taxation like sole proprietorships and partnerships. These two assets make LLCs an extremely advantageous structure for small to medium size businesses.
When you form an LLC, you begin the process of separating your personal assets from the assets of your business. The LLC becomes a separate legal entity that holds its own assets separate from your personal assets like your car, home, and personal bank accounts.
This separation is sometimes known as the corporate veil. Many things go into maintaining a corporate veil, but forming an LLC to separate your business assets from your personal belongings is the best way to start.
Personal asset protection means that LLC owners are personally protected from debts and lawsuits brought against the company. The personal assets of the owners are sheltered from the liability of the business. If the business faces a lawsuit, goes through bankruptcy, or encounters other types of loss, creditors may not seize the owner’s personal properties to cover the debt.
LLCs have become the business entity of choice for small businesses because it offers a more convenient, flexible, and less-expensive alternative to corporations while providing the same level of personal asset protection.
Pass through-taxation means that LLCs do not pay corporate taxes. Instead, business profits are reported on the LLC member’s individual tax return. The profits literally “pass-through” the LLC directly to the owner.
For single-member LLCs, the income tax due is determined by the owner’s entire net income calculated on Schedule C of the owner’s personal Form 1040. This means that your business’s income will be added to any other personal income (like that of a job) to find the total income for tax purposes.
If your LLC has more than one owner, things get a little more difficult. For multiple-member LLCs, the tax is divided among the members/owners. Each individual member/owner receives a Schedule K-1 showing their share of the profit, which is included on the member’s Form 1040. The total income shown on the K-1 is then added to your personal income just like in a single-member LLC.
An LLC can also decide to be taxed as an S corporation or a C corporation, which provides tax flexibility for its members. Further details of LLC taxes and corporation elections are a bit out of scope for this article.
While all LLCs provide the same major features (personal asset protection and pass-through taxation), some LLCs are designed for more specific needs. Here are some common types of LLCs available to businesses:
Owners of an LLC are called members. An LLC can legally be owned and operated by one person, but there is no limit as to how many owners (members) can be involved in the company. Members (owners) may include individuals, corporations, or other LLCs and foreign entities. LLCs can be formed with just a single member (Single-Member LLC) or many members (Multi-Member LLC).
To determine the management structure, you will need to decide whether your LLC business will be managed by a member or a manager. This decision is specified in the Articles of Organization that is filed with the state to form the LLC.
Typically, an LLC is managed by its members (Member-Managed), where all members make decisions when it comes to their daily business operations.
In some cases, however, members will assign a manager (Manager-Managed), where the members choose one or more managers (may or may not be members) to manage the business. Manager-Managed LLCs are considerably less common than Member-Managed LLCs.
The steps to forming an LLC will vary from state to state. Compliance with state law is important and you need to ensure that you follow these steps properly to get your company up and running.
These are the six basic steps in forming an LLC:
The processing time of your LLC’s formation varies greatly by state, with the average being somewhere in the one to three-week range.
Once your LLC has been accepted by the state, you’ll need to obtain any licenses, permits, or certifications required to legally operate your business.
LLC formation costs depend on the state where you registered your business. From filing your articles of organization to reserving your LLC business name, the exact amount for these fees varies from state to state. In most states, forming an LLC yourself will generally cost between $50 and $500.
If you choose to have an LLC formation service file your LLC for you, you can look to tack on $39 – $249 for the service. Most people choose to use these services instead of forming on their own due to the low cost and the verification that it will be done right the first time with little to no headache.
There are three states (Arizona, Nebraska, and New York) that require you to publicize the formation of your LLC in local newspapers. This will increase the overall cost of your LLC formation by anywhere from $50 to $1,200 depending on your location. This is also something that an LLC formation service can help you to take care of.
The LLC is a preferred business structure among small business owners because it is simple and easy to create and less complicated to manage, along with several other advantages.
While there are many benefits to forming an LLC, there are also a few disadvantages:
LLCs have features that set them apart from other types of businesses. Here are the main differences between LLCs and other types of business structures.
A corporation (also referred to as standard corporation or C-Corporation) is a state-incorporated business. Like LLCs, corporations provide high liability protection for the owners.
Unlike LLCs that benefit from pass-through taxation, corporations are double-taxed. Being double-taxed means that the corporation is taxed on its corporate profits and the shareholders also pay tax on the dividends from those profits.
A sole proprietorship is similar to a single-member LLC, where it only consists of one person managing the business. Like LLCs, sole proprietorships are pass-through taxation entities, where owners only file personal income tax and do not pay a corporate tax on their business.
Unlike LLCs that provide personal asset protection, the owner (sole proprietor) is responsible for all of the assets and liabilities of the business. In the event of business failure, the sole proprietor is held responsible to pay and settle the debts and liabilities that the business incurred.
In a partnership, the owners manage and control the business, and all profits flow directly through the business to each partner. Like LLCs, partnerships are considered pass-through taxation entities. Unlike LLCs, partnerships do not offer liability protection. The partners are subject to any debts and liabilities that result from the business operations.
An LLC is a business structure that provides the personal liability protection of a corporation with the pass-through taxation benefit of a sole proprietorship or partnership.
The LLC was created as a legal business entity by the state of Wyoming in 1977 to provide businesses a way to be taxed like partnerships, but have liability protection like a corporation. By 1996, all 50 states had LLC statutes. The simplicity and cost-effectiveness of the LLC business entity have made opening small businesses possible for millions of entrepreneurs since then.
The most simple place to form an LLC is in the state where your business will be located. In rare cases, some businesses may benefit from forming in a state like Delaware or Nevada.
LLC owners are called members.
LLC owners are not considered employees of the company.
All states require LLC members and managers to be at least 18 years of age. They do not have to be US citizens; there is no residency or legal restriction as to who can form an LLC in their home state or another state.
There is no limit to how many LLCs you can create and operate as long as each LLC follows formation requirements and state regulations.
LLCs do not have shareholders; they cannot sell shares on the stock market. LLCs also are not required to have a board of directors. Instead, an LLC is owned by its members, who divide the business earnings among each other.
An inactive LLC means there is no business activity over a specific year. Even if your business is inactive, any earnings you receive during a year must be reported as normal. If you need to end your LLC’s inactivity, you will go through an official process of dissolution with the state you registered your LLC in.
Information on this page has been gathered by a multitude of sources and was most recently updated on June 2021.
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