What is an LLC

Forming an LLC is one of the simplest ways to protect yourself and your business. But is it the right fit for you? Learn everything you need to know.

Although they're newer than other business structures, LLCs are a top choice among business owners. Especially for small- to medium-sized companies.

They're simple, flexible, and offer liability protection—a hybrid of sole proprietorships/partnerships and corporations. This gives entrepreneurs the best of both worlds. But they're not always the best choice for everyone.

Here's everything you need to know about an LLC, from what it is to how to form one. Check to see if it's what your business needs.

What is an Limited Liability Company (LLC)?

An LLC, or "Limited Liability Company," is a business structure that offers personal liability protection. It draws a clear line between the company's assets and the owners' personal ones. This protects business owners if their company faces issues like lawsuits, debts, and bankruptcy (liabilities).

You won't risk losing your house, car, and other personal properties. Even if your business struggles or goes under.

Advantages of LLCs

LLCs offer many other benefits to business owners because of their unique nature. Let's discuss some of them below.

Personal Liability Protection
LLCs are considered separate entities from owners. This gives business owners personal liability protection that safeguards their personal assets.

The government or banks can't seize a member's belongings or properties if the business goes under—only what the company owns.

The only condition is they have to establish that the company's assets are separate from the members' assets. LLC members have to show they're not using the business' finances for their personal purchases.

Simple Taxation
LLCs can opt for what's called "pass-through taxation." This means they don't have to pay taxes twice on the same income, unlike corporations. Owners will just file them as part of their personal income tax returns.

They can also choose to be taxed like corporations or S corporations. You can read about this in more detail in the taxing section.

The Simplest Way to Establish Credibility
Forming an LLC is also the simplest way to formalize your small business and establish it as a legitimate company. You just have to file your Articles of Organization with your Secretary of State's office to officially become an LLC.

Becoming an LLC will also allow you to open a separate business bank account since your company will now be treated as a separate entity. This can make it easier to get business financing. It'll also make separating your personal and the company's finances more convenient.

Anyone Can Start One
Anyone can turn their business into an LLC. In fact, you don't have to be a U.S. citizen or resident to form one. Only institutions like banks and insurance companies aren't allowed to turn their businesses into LLCs.

Owners are called "members" in LLCs, and you can have as many as you want with this structure. You can also start an LLC with yourself as the sole member—these are called "single-member LLCs."

Flexible and Adaptable
An LLC offers a more flexible management structure. You can choose to hire a manager to oversee its operations (manager-managed) or do so yourselves (member-managed). You just have to make this clear in your company's Operating Agreement.

Fewer Restrictions
The government imposes fewer restrictions and requirements on LLCs. For example, they don't have to establish a board of directors or hold annual meetings like corporations.

They also deal with less paperwork since they don't have to be strict with recordkeeping and documentation. Members just have to show that the company's finances are separate from their own to get limited liability protection.

It allows businesses to continue operating even if one member dies or leaves the company. Some states might require the LLC to end/dissolve when this happens, but this isn't usually the case. Only single-member LLCs end if the sole member dies or leaves.

Business Structure Quiz

Disadvantages of LLCs

Of course, LLCs also have their fair share of disadvantages. Some of them include:

• Pass-through taxation applies to all members. Even if they don't receive dividends (payments) from the company.
  
• They can still be subjected to other types of taxes (like franchise or capital values tax).
  
• Fewer requirements for operations can sometimes lead to poor management.
  
• All members have to approve a new member in the company.

6 Types of LLCs

LLCs can be categorized into six types.

Single-Member LLC

Single-member LLCs are just limited liability companies with only one member/owner. These are similar to sole proprietorships since they also have only one business owner.

They're also taxed like sole proprietorships. You pay taxes for your LLC on your own personal tax return. You can see how they differ in the LLC vs. Sole Proprietorship section.

You get all the benefits and personal asset protection of being an LLC, even with only one member. You can even hire employees on payroll or as contractors.

Multi-Member LLC

Multi-member refers to LLCs with two or more members. There's generally no limit to how many members you can have in this LLC type. Unless you're going for an S corp tax classification.

This LLC type is taxed as a partnership except when members elect a C-corp or S-corp tax classification.

Unlike single-member LLCs, multi-member LLCs need to have all members' approval before they can make any changes to the business, like adding new members.

Domestic LLC

Domestic LLCs are businesses registered as LLCs in their "home" state, where they conduct most of their business.

For example, you register as an LLC in California. That means you'll be considered a "domestic LLC" in that state. It also means your company will mainly follow California's business laws and regulations.

Foreign LLC

Contrary to popular belief, foreign LLCs are NOT companies formed or operated outside the U.S. They're just companies doing business outside their home state.

Most states require non-domestic LLCs to register as foreign LLCs if they meet specific criteria. For example, opening a new office or branch outside your home state will mean registering as a foreign LLC in that state. This ensures a company's compliance with local laws and regulations when doing business in other states.

Professional LLC

Professional LLCs, or PLLCs, are limited liability companies designed for licensed professionals (e.g., doctors, accountants, lawyers, etc.).

Most states don't allow these professionals to register their businesses as regular LLCs. They don't want professionals to avoid the legal consequences of professional malpractice. PLLCs also protect them from malpractice committed by their business partners.

Series LLC

Series LLCs are just several LLCs (series) operating under one primary LLC (parent/umbrella). Each series is considered a separate company from the parent LLC and the others.

They have their own operating agreements, members, and assets, but are considered one part of a whole. Each also has its own liability protection, so legal action against one won't affect the others and the parent company.

LLC vs. Corporation

Corporations, also known as "C corporations," are formal business structure that classifies the company as a separate entity from its owners.

Here's a comparison with LLCs.

Similarities

• Liability Protection: Corporations and LLCs are considered separate entities. So, they offer business owners protection for their personal assets.

• Multiple Owners: LLCs and corporations can also have several owners. They're called "members" for LLCs and "shareholders" for corporations.

• Formation: Both LLCs and corporations must register their companies with the state. They also need to file official paperwork. For corporations, these are called "Articles of Incorporation." They contain similar information as an LLC's Articles of Organization.

• Registered Agent: The government requires both company types to have a registered agent. Registered agents are individuals or agencies that receive official documents on behalf of a company.

Differences

• Double Taxation: Corporations have to pay taxes twice on the same income. Once on a corporate level, and another on the individual shareholder level. LLCs can choose to be taxed like a pass-through entity, meaning you only pay taxes once on your personal tax returns.

• More Requirements: The government imposes more requirements on corporations. They must have a board of directors, hold annual shareholder meetings, and create company bylaws. LLCs only need to file annual reports.

• Stricter Recordkeeping: Corporations must be strict with documentation, especially when recording company meeting minutes. The government requires these as compliance. LLC members only need to keep business and personal finances separate.

• Ownership Transfer and Issuing of Shares: Corporations are the only business entities that can issue company shares and go public. This makes it easier for investors to become part of a business. They can also sell stocks at any time to raise capital when needed.

LLC vs. S Corporation

S Corporations are NOT business entities. They're a tax classification designed to reduce the taxes corporations have to pay without losing their corporate status.

Here's how they compare against LLCs.

Similarities

• Liability Protection: S corporations are still corporations, so they enjoy the same limited liability protection as C corporations. LLCs also have this protection.

• Pass-Through Taxation: An S-corp tax classification passes the taxes on company profits through the shareholders' personal income tax returns. Like LLCs, you don't have to pay taxes twice as an S corporation.^[2]

• Registered Agent: S corporations must have registered agents like regular corporations and LLCs.

Differences

• Ownership Limitations: S corporations have more restrictions when it comes to ownership. For example, all shareholders must be U.S. citizens or residents. They can only have 100 or fewer shareholders to retain S-corp status.^[3]

  You don't have to be a U.S. citizen or resident to become an LLC member. They can also have an unlimited number of members.

• Same Management as Corporations: Unlike LLCs, S corporations have to follow the same laws and requirements as corporations (e.g., have a board of directors, company bylaws, and annual meetings).

• Transferrable Shares: S corporations also have easily transferrable shares. They can make anyone a shareholder by selling company stock to them. The only difference from regular corporations is that they can only issue one class of stock.

• Better Self-Employment Tax Rates: S corporation shareholders generally pay lower self-employment taxes than LLC members. They're considered employees instead of business owners.

LLC vs. Sole Proprietorship

Sole proprietorships are informal businesses owned by a single individual. Here's how it compares against single-member LLCs.

Similarities

• Only One Owner: Both sole proprietorships and single-member LLCs only have one owner/member.

• Pass-Through Taxation: Sole proprietorships are also pass-through entities, so business owners have to file taxes as part of their personal income tax returns. Single-member LLCs are taxed as sole proprietorships by default.

• Flexible Management: Sole proprietorships and single-member LLCs don't have to consult with others when making changes to the business.

• Lifespan: Sole proprietorships are also dissolved when the only owner dies. But, single-member LLCs can continue if their operating agreement includes a way to determine a successor.^[4]

Differences

• Liability Protection: Single-member LLCs get limited liability protection since they're considered separate entities. Sole proprietorships aren't, so the owner's assets are considered the same as the business' assets.

• Formation: You also need to register single-member LLCs with the state like you would multi-member LLCs. You don't need to do this with a sole proprietorship.

LLC vs. Partnership

Partnerships are an informal business structure that involves two or more people starting a business together. Let's see how they compare against LLCs.

Similarities

• Pass-Through Taxation: Partnerships are pass-through entities. Owners only file taxes for business profits as part of their personal income tax returns. The IRS considers multi-member LLCs as partnerships by default, so they enjoy the same process.

• Flexible Management: Business partners only have to agree on how they want to run their business and share the profits and liabilities. LLCs function similarly to their Operating Agreement.

• Multiple Owners: LLCs and partnerships can have multiple members or partners. But, only LLCs have the option of single ownership.

Differences

• Liability Protection: LLCs have limited liability protection since the company is considered a separate entity and has its own assets. Partnerships aren't regarded as different from the owners. So, they're still at risk of losing their personal assets.

• Formation: Partnerships have a more straightforward formation process. Business owners don't have to file official paperwork or documents to establish one. LLCs have to register with the state to become one.

• Lifespan: LLCs can continue operating even if one member dies or leaves the company. Business partnerships end when this happens. The remaining partners need a new agreement if they want to continue the business.

How to Form an LLC

Most states follow the same LLC formation process, with some minor differences.

Step 1: Choose Your Business Name

Choosing and registering a business name is the first step to forming an LLC. Your chosen name should be unique to your business. No other company in the state should have already registered your chosen name.

It also shouldn't be too similar to any existing businesses registered in your state. Be aware of any restrictions when naming your business.

Most states require adding words that identify your business as an LLC to its name. Some examples are "LLC," "Limited," or "Limited Liability Co." Double-check your state's official website to be sure.

If you don't know if your preferred business name is still available, you can check your state's online business name database to verify.

You can reserve your preferred business name for a small fee if you're not forming your LLC yet. Just remember that reservations only last a few weeks (30 to 60 days in most states). So make sure you form your LLC before it expires.

Step 2: Assign a Registered Agent

Businesses must have a registered agent on file when forming an LLC or a corporation. This is true for all states.

Registered agents act as a company's primary point of contact. They receive legal documents like tax notices, subpoenas, and lawsuits on behalf of a business. They also make sure these documents are forwarded to the right person in the company.

Some states serve as the default registered agents for all registered companies in their jurisdiction. But, you can still appoint your own if you want.

Generally, you can assign anyone as your company's registered agent—even yourself—as long as they meet the following criteria:

• 18 years old and above
  
• Has a physical address in the LLC's formation state (PO Boxes not allowed)
  
• Always available during business hours to receive documents

Some states have different laws and restrictions, so double-check before assigning someone to the role.

Step 3: Create Your Operating Agreement

An operating agreement acts as your company's default rules and regulations. It contains information about your company's operations, like the specific duties of each member, how you'll handle key decisions, and other specific terms and conditions.

Most states don't require businesses to include them when filing to become LLCs. Only California, Missouri, New York, and Maine do.^[5][6][7][8]

But creating one for your company has its benefits. It can keep your business running smoothly and allow you to handle conflicts more efficiently. An operating agreement gives your business its own protocol. Without one, you'll have to use your formation state's default operating laws.

Step 4: File Your Articles of Organization

The next step would be to file your Articles of Organization with your secretary of state's office. This is also called "Certification of Formation" in some states.

It usually contains the following information:

• Business name
  
• Official company address
  
• The business' purpose
  
• Registered agent
  
• Registered agent's office
  
• Management structure (member- or manager-managed)
  
• List of LLC members' names and addresses
  
• Duration
  
• Effective date (if your LLC won't start right away)

The exact forms you need to fill out differ from state to state. You can find them on the state secretary's official website, and file them online or by snail mail.

You can also check how much the filing fees are in your state. They usually range from $50 to $150, but some states charge as high as $500.

Once the state approves your application, you'll receive your company's "Certificate of Formation." This certifies that your company is now a legitimate business entity, so make sure you keep this in a safe location.

Step 5: Check and Follow Other Requirements

After forming your LLC, you should also check what other requirements you need to follow. Some of these are:

• Getting your employer identification number (EIN)
  
• Applying for the necessary business permits and licenses (county, state, and federal)
  
• Opening a business bank account
  
• Publishing an announcement in the local paper

Getting an EIN is critical because you'll need it to pay your company's taxes. This is true even if you opt for pass-through taxation. You also need an EIN to open a business bank account.

You don't need business permits or licenses to form an LLC. But, you need them to legally do business in the state. You might need additional permits or licenses if your business is in a more specialized industry (e.g., agricultural, broadcasting, finance, etc.).

Besides these, some states, like New York and Arizona, require newly formed LLCs to make an announcement in their local newspaper.^[11][12] Make sure you check beforehand to avoid any problems.

How Are LLCs Taxed?

LLCs enjoy the most tax flexibility because they can choose to be taxed as one of the following:

• Sole Proprietorship
  
• Partnership
  
• C Corporation
  
• S Corporation

The main difference is with how many members your LLC has. Some states also charge separate LLC taxes or fees, so check if it's the same in your state.

As a Sole Proprietorship or Partnership

LLCs are taxed like sole proprietorships (for single-member LLCs) or partnerships (for multi-member LLCs) by default.

Like them, LLCs enjoy pass-through taxation because the IRS considers them disregarded entities for federal tax purposes.^[13] Members don't have to pay separate taxes for the company. They can file these as part of their personal income tax returns via Form 1040 (single-member) or Form 1065 (multi-member).

The downside is that LLC members still need to pay self-employment tax. This means paying income taxes as employers AND employees, usually resulting in higher rates.

As a C Corporation

LLCs can also choose to be taxed like a C corporation. This means they'll have to pay taxes for the same income on corporate and individual levels (double taxation). But members won't have to pay higher self-employment taxes. They'll be considered salaried employees instead of self-employed.

To file taxes as a C corp, you need Form 1120.

As an S Corporation

Choosing an S corporation tax classification means your LLC can enjoy pass-through taxation (like sole proprietorships or partnerships) and lower self-employment rates (like corporations).

But, this also means your company will be subjected to additional rules and restrictions. You have to comply with them if you don't want the IRS to revoke your S-corp status.

S corporations use Form 1120-S to file taxes.

FAQs

How much does it cost to form an LLC?
Filing fees are the main cost of forming an LLC. They vary from state to state ($50 to $150 for most areas). You'll need to check your secretary of state's website for the exact rates.

Other fees to consider include:

• Business name reservation fee
  
• Business licenses and permits
  
• Publication fees
  
• DBA fees (if needed)

How long does it take to form an LLC?
It'll depend on how fast the state can process your application. Most areas only take 7 to 10 business days, while others can take as long as 4 to 6 weeks.

Some online incorporation services offer expedited processing for an extra fee.

What is an LLC license?
An LLC license just refers to its official paperwork establishing it as an LLC—Articles of Organization. You don't need a license to form an LLC.

Can I form an LLC in another state?
Yes, you can. Business owners have to form their LLC where their business will operate, not where they live. They will need to register as a foreign LLC in other states if they want to do business outside their home state.

Do I need a lawyer to form an LLC?
No, you don't need to hire a lawyer to form an LLC. You can file the documents yourself. Online incorporation services can also file the paperwork on your behalf. You can still hire a lawyer if you need more guidance.

Who should manage my LLC?
A member-managed structure is the default arrangement for most states. You can also choose to delegate the responsibilities to a manager (manager-managed).

Some states require you to include this information in your Articles of Organization. But most just need members to give their approval and state this in the company's Operating Agreement.

Bottom Line

An LLC combines the best of both types of business structures. You get the flexibility of partnerships and the protection of corporations in one. It also gives you more options in terms of taxes.

But, it's not without its downsides. Make sure you do your research and learn more about the different business structures to see which one's right for your business.

References