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 discuss everything about LLCs, show you a brief overview of how they work, and give you what you need to get started with your business.
How does an LLC work?
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.
LLC Personal Asset Protection
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.
LLC Pass – Through Taxation
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.
Types of LLCs
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:
- Domestic LLC – A Domestic LLC operates its business in the state in which it was formed. All your Domestic LLC activities are carried out in the state where you registered it. A domestic LLC is the most common type of LLC.
- Foreign LLC – If you form an LLC in another state, you’ll need to register it as a Foreign LLC. For example, you form an LLC in California (which is your home state), but you are also going to transact business in Texas, you’ll need to register your business as a “Foreign LLC” in Texas. If your business is run fully online, it is considered to be transacting business in your home state.
- Professional LLC – A Professional LLC caters to licensed professionals, such as doctors, lawyers, accountants, engineers, and architects. To form this type of LLC, you and your members need to have the required state licenses to demonstrate your professional credentials. Some states place restrictions on these professional industries that don’t allow them to create LLCs. For example, you may not start an LLC if you are a healthcare provider, an architect, or an accountant in California. For businesses in these industries, you must use a different business structure like a corporation.
- Series LLC – A Series LLC (or SLLC) is a unique LLC type and considered a “parent” or “master” LLC with separate sub-LLCs beneath it. Each sub-LLC has its liability protection separate from each other and the “parent/master” LLC. This is generally used in real estate businesses.
- L3C – A Low-Profit Limited Liability Company offers the right mix of tax flexibilities of a traditional LLC, the social purpose of nonprofits, and the positioning of a social enterprise.
Member-Managed vs Manager-Managed LLCs
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.
How to Form an LLC
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.
Tip:To find your state’s specific LLC formation steps, check out our page: How to Form an LLC. If you would like a professional to take care of this task for you, check out our review of the Best LLC Services.
These are the six basic steps in forming an LLC:
- Choose your state – Generally, it is best to form an LLC in your ‘home state’ – the location where you live and your business is going to be based. If you are planning to conduct business in another state (besides your home state), you’ll need to register it as a “Foreign LLC” in the state you are transacting business in.
- Name your business – Find and decide on a unique business name and ensure that it complies with all of the LLC regulations of your state. The name must include a designator which indicates it is an LLC, such as “Limited Liability Company,” “LLC” or “L.L.C.” (Example: My New Business, LLC)
- Nominate a registered agent – When forming an LLC, you are required to appoint a registered agent. A registered agent is an individual or business entity that accepts tax and legal papers on your LLC’s behalf. A registered agent is also referred to as a resident agent or statutory agent. Your registered agent must be a resident of the state your business is based in. The agent can be yourself, a registered agent service, or a professional as long as they meet the criteria of your state. It’s common for businesses to use a registered agent service, as the fees are generally low and there are a host of benefits to not being your own registered agent.
- File Articles of Organization – Articles of Organization (also called the Certificate of Formation or Certificate of Organization) is the document file with the state to officially form your LLC. You will generally complete this step on the Secretary of State’s website and pay a fee to file.
- Create an LLC operating agreement – An LLC operating agreement outlines the ownership structure, member roles, operating procedures, and other general information that will be in the LLC members’ agreement. This document isn’t filed with the state. Rather, it’s a document that you will keep in your own records until it’s needed.
- Get an EIN (Employer Identification Number) – An EIN, or Employer Identification Number, is used by the US Internal Revenue Service (IRS) to verify and tax businesses. An EIN is also used to hire employees or open a business bank account. Once you’ve formed your LLC you can get your business’s new EIN number from the IRS website.
After Forming Your 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.
How Much Does It Cost to Form an LLC?
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 $29 – $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.
Recommended ServiceIf you want to save time and ensure your LLC filing is properly taken care of, consider using a professional LLC service. We recommend Northwest Registered Agent services, which only charges $29 + state fees.
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.
What are the Benefits of an LLC?
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.
- Liability protection (personal asset protection) – An LLC allows its owners/members to invest without risk of personal losses beyond their investments. The owners are not held responsible for any debts and liabilities associated with the business.
- Pass-through taxation – All profits and losses are passed through to the personal income tax returns of its members. The LLC itself is not taxed as a business entity, which means that the owners/members avoid double taxation.
- Easy formation and maintenance – An LLC is easy to set up and maintain without corporate regulations. It can be set up with only one member or multiple members.
- Choice of tax treatment – An LLC can also elect to be taxed as a C Corporation or an S Corporation, partnership, or sole proprietorship, depending on what is most beneficial to the business and its owners.
- Flexibility in ownership – LLC owners/members do not need to be US citizens or permanent residents of a specific state. An LLC can be owned by individuals, another corporation, or entity.
What are the Disadvantages of an LLC?
While there are many benefits to forming an LLC, there are also a few disadvantages:
- Regardless of the LLC’s tax status, each owner/member must report any personal income derived from the business. LLC owners may choose to reduce their individual self-employment tax by electing to have the LLC formed as an S Corporation or C Corporation for tax purposes.
- LLC members are considered self-employed and will be subject to Social Security and Medicare taxes.
- If you are looking for outside investors, such as venture capital funds, they are less likely to fund LLCs because they simply cannot invest in pass-through taxation entities if the fund has tax-exempt partners. This is an area where forming a corporation can be advantageous.
Differences Between LLCs and Other Types of Businesses
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.
LLC vs Corporation
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.
LLC vs Sole Proprietorship
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.
LLC vs Partnership
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.
What is an LLC FAQ
What is an LLC?
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. See above for more information.
When was the LLC business structure created?
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.
What is the best state to form an LLC?
What are LLC owners called?
LLC owners are called members.
How do LLC owners get paid?
LLC owners are not considered employees of the company.
What are the age requirements for forming an LLC?
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.
How many LLCs can I have?
There is no limit to how many LLCs you can create and operate as long as each LLC follows formation requirements and state regulations.
Do I need a lawyer to form an LLC?
Does an LLC have shareholders and a board of directors?
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.
What happens if my LLC is inactive?
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. For more information, see our How to Dissolve an LLC page.
Information on this page has been gathered by a multitude of sources and was most recently updated on July 2022.
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