You’ve likely come across the acronym “LLC” when researching how to start a business. But what does it mean? In this article, I’ll tell you everything about what “LLC” means.
The Meaning of “LLC”
If you’ve ever asked “What does LLC mean?” you’re not alone. But don’t worry, I’ll explain.
LLC stands for “limited liability company.” What is that? Well, a limited liability company (LLC) is a type of business structure exclusive to the United States. It provides LLC owners with personal asset protection, including the personal liability protection associated with corporations (such as an S corporation or C corporation) and the pass-through taxation benefit associated with sole proprietorships.
In other words, a limited liability company combines the benefits from two different business types (corporations and sole proprietorships), so as a business owner, you get the best of both worlds.
LLC Members
A limited liability company (LLC) with only one member is run by an LLC owner. The term “LLC owner” is just the term used to refer to the owner or owners of these businesses. If a limited liability company is run by multiple members, they are referred to as LLC members.
Typically, LLC members are part of a board. The board has regular meetings to discuss and make high-level decisions for the company, typically through voting. Your state’s governing body (such as the Secretary of State) may regulate how often members meet and how they conduct meetings, but the regulations of these meetings are less rigid than the meetings of corporations.
Who Should Form an LLC?
You’re probably reading this article and wondering whether you should form an LLC, or what types of businesses should form LLCs. I’ll discuss some of the factors that go into many business owners’ decisions to form an LLC so that you can make the decision yourself.
First, LLC owners benefit from personal liability protection. That’s a complicated legal term that means that when you create a limited liability company, your business becomes a separate entity from you. This business structure differs from, say, an S corporation or a sole proprietorship, because in those business structures the lines between the individual, the business entity, and the company’s profits are blurred.
But the owners of limited liability companies can rest easy knowing that their personal assets are safe. This peace of mind is possible because the owners of limited liability companies cannot be held personally responsible for the business debts or liabilities resulting from their business operations.
So, personal assets such as the funds in your personal bank account, your home, any vehicles you own, or any other assets you’ve amassed over the years remain safe—no matter what happens to your company—because you aren’t personally liable for your company’s financial troubles.
Second, filing paperwork for LLC formation is easy, especially compared to other business entities. There tends to be less paperwork involved in the whole process, meaning it can take less time to get your company off the ground and operational.
Finally, limited liability status is attractive to both creditors and customers. Most people tend to view a company with LLC status as being more credible or trustworthy than other types of business entities (like corporations or a sole proprietorship). You can take advantage of this to increase company profits.
If you think you might like to form an LLC but you’re worried about taxes, you should know that your business entity won’t experience double taxation, unlike corporations.
LLC Tax Advantages
One of the major reasons that business owners choose to form LLCs is all the tax benefits that LLC owners experience. When you form an LLC you avoid what is known as “double taxation.”
Don’t understand corporate taxation? Allow me to explain. S corporations (as well as other corporations) pay taxes on their profits twice. Profits of a corporation are taxed at corporate rates, then are distributed to corporate shareholders in the form of dividends, which are taxed at personal income tax rates before shareholders access the money.
An LLC’s profits are only taxed once. First, the profits are taxed at company tax rates (which aren’t as steep as corporate tax rates). Then they are provided to LLC members as personal income. This isn’t immediately taxed, but will rather be taxed when the members file their personal tax returns for the year.
Furthermore, thanks to QBID (the Qualified Business Income Deduction), which Congress passed in 2017 in accordance with the 2017 Tax Cuts and Jobs Act. QBID provides LLC owners with a 20% discount on their taxes. This benefit is exclusive to LLCs, so you won’t qualify for it if you form a sole proprietorship or corporation.
When you form an LLC, you have the option to file taxes using either the “default LLC” option or an “S corp” designation.
Business owners who use an S corp designation must pay both income tax and a self-employment tax on a predetermined set salary amount. Then profits that are distributed to members are only subject to income taxation.
This differs from the “default LLC designation,” wherein the company’s profits “pass through” the personal tax return of the owner. Owners or members are then required to pay both income and self-employment taxes on the total amount of the profits.
Both designations have their benefits, and the Internal Revenue Service (IRS) finds either designation valid for LLCs.
How to Form an LLC
Now that you know what an LLC is and some of the reasons that typically help business owners decide to form an LLC, you should now know whether this is the right structure for your business. Below are the steps you’ll need to form an LLC:
*IMPORTANT* If you’ve never formed an LLC before and you want professional help to guide you through the red tape, help you keep track of every filing fee you need to pay, as well as help you with many of the legal needs that may pop up while going through the formation process, the good news is that there are professional services for just that. They’re called LLC formation services, and you can find them for as little as $0 plus state filing fees. However, my favorite is Northwest Registered Agent, which charges $39 plus the state filing fees. If you’d like to know more about LLC formation services, check out my article about the best LLC service.
Step 1. Obtain the Articles of Organization form
You can typically obtain the Articles of Organization (called the Articles of Formation form in some places) from your state’s governing entity (like the Secretary of State). Submission methods vary from state to state, and the filing fee varies, as well.
Step 2. Choose your business name
One of the first bits of information required on your Articles of Organization form is the name of your business. Most often, you’re not allowed to use the same name as another business in your state. It’s easy to use your state’s online business name database to perform a business name search, however. Then you’ll have to file a Name Reservation form, for which you’ll likely have to pay a fee.
Step 3. Choose your registered agent
Most states require LLCs to have what are known as “registered agents.” A registered agent is a person or entity who will accept mail, legal documents, and service of process on behalf of your company.
Many businesses choose to take on the registered agent responsibilities themselves, but there are a lot of legal ramifications for doing so. You’ll need to be available during normal business hours to receive legal documents, and most small businesses are also open during those hours, which makes running the business and accepting mail difficult. So, it’s a wise decision to choose a separate business entity for the task.
For more about registered agents, check out my article Best Registered Agent Services.
Step 4. Choose your LLC address
Another piece of crucial information required on your Articles of Organization form is your LLC address. The address you list will be displayed on the public record by your state’s governing entity. Ideally, you should list your company’s physical address. If you don’t have one, then you’ll have to list your home or office address, which leaves your information vulnerable to cybercriminals and hackers. A registered agent, however, will list their address, instead of yours, on the form so that your information will remain secure.
Step 5. Sign and file your Articles of Organization
After you’ve filled out your form and listed all the vital information, it’s time to sign and file your Articles of Organization. Again, if you sign the document yourself, your personal information will be on public record. But if you use an LLC formation service, they will list their information instead of your own. Each state has their own submission methods and filing fees for submission, and you may be required to submit other documents along with this one.
After Starting Your LLC
Your work isn’t done once you’ve filed your Articles of Organization. Here are a few of the things you’ll need to do after you’ve formed your LLC:
Create an operating agreement
Most states don’t require you to create an operating agreement, but most legal services advocate for it. An LLC operating agreement is important because it dictates the payment of LLC members, how the business should run, various departments, their duties, and how they should interact with each other, and what should happen if LLC members leave. If you prefer to draft your own operating agreement, Northwest Registered Agent provides a free operating agreement template that you can get here.
Apply for an employer identification number
If you want to hire employees or open a business bank account, it’s important that you obtain an employer identification number (EIN) from the Internal Revenue Service (IRS). An EIN is an identification number that identifies businesses similar to the way a social security number identifies individuals. All you have to do is go to the IRS website Monday–Friday between 7 a.m. and 10 p.m. to submit your application.
Open a business bank account
The last step in establishing your business on solid foundations is opening a business bank account. It’s important to keep your LLC’s profits separate from your personal finances. Your personal asset protection is completely nullified if you don’t keep your personal and LLC assets separate and draw that line in the sand.
Opening a business bank account is also important for tax purposes. When you combine both personal and business transactions in one account, filing taxes can become very confusing. It may seem like you’ll be able to recall which transactions were made for which purpose, but many of these purchases were made several months before tax season approaches.
So to simplify your life, open a business bank account.
In Summary
An LLC, or limited liability company, is a type of business structure exclusive to the United States that establishes a business as a legal entity separate from the business owner. This provides LLC owners with personal asset protection that isn’t available if you choose a different structure, such as a sole proprietor.
You get a number of tax benefits from forming an LLC, and you can choose to be taxed as a default LLC, or as an S corp. LLCs taxed as S corps are taxed differently than the standard default LLC taxation.
If you’d like to learn more about how to form an LLC, check out my article about How to Form an LLC.
