What Is an LLC?


The acronym LLC stands for Limited Liability Company and has become one of the most popular business structures for small businesses in America. But what is an LLC?

A Limited Liability Company is a business structure that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation. LLCs are an excellent business structure if you want the same personal liability protection as a corporation but also want greater control over how your business is taxed and organized.

LLCs are legally considered a hybrid business entity and combine elements of a corporation with that of a sole proprietorship or partnership (depending on the number of members) with a corporation. The members of an LLC receive limited liability protection, similar to a corporation. The element an LLC shares with a partnership or sole trader is the availability of pass-through taxation for its members.

Although some features of corporations, partnerships, and LLCs are similar, there is a legal distinction between an LLC and other business entities. An LLC is “organized” instead of being “chartered” or “incorporated,” and the primary formation document LLCs require is referred to as the “Articles of Organization,” though the exact name for this form may vary from state to state.

Benefits of an LLC

Many small business owners choose a Limited Liability Company (LLC) over other structures such as sole proprietorships, for the limited liability and asset protection that an LLC provides. This separates your business assets from your personal assets and establishes your business as a separate legal entity. This means that LLC owners aren’t personally liable for the LLC's liabilities and debts and it protects your personal assets and finances from being listed as a means of compensation in the event of your LLC’s bankruptcy or a lawsuit.

Aside from personal liability protection, another major benefit to establishing an LLC is pass-through taxation to its owners. Profits (or losses) incurred by the company are passed through to the business owner’s personal tax returns. Profits earned in this manner are taxed at the owner's personal tax rate.

When you form a corporation, the profits are taxed at corporate rates first and then distributed to corporate shareholders in the form of dividends (which are also subject to personal income tax). This corporate tax phenomenon is referred to as “double taxation.”

When you establish an LLC, you avoid “double taxation” entirely. Profits earned by your LLC are taxed at company rates (which are lower than corporation rates) and then disbursed to LLC members as personal income. Due to this taxation approach, your LLC only has to pay tax on its earnings once.

Single-member LLCs are often taxed identically to sole proprietorships. Profits, losses, and deductions from the LLC are reported on IRS Schedule C and filed with the business owner's personal tax return. For tax purposes, an LLC with multiple members is often regarded as a partnership. Profits and losses are again recorded on the owner’s individual state and federal income tax returns and taxed at their individual rates.

Because LLCs are often pass-through companies, their owners benefit from the Tax Cuts and Jobs Act's unique pass-through tax deduction. The Qualified Business Income Deduction is a new tax break for limited liability companies that was introduced in the 2017 Tax Cuts and Jobs Act. This allows most LLC owners to get a tax advantage of up to 20%, which is not available if you choose another company structure, such as a sole proprietorship. This deduction began in 2018 and is expected to remain in place until 2025.

LLCs are also incredibly simple to form. Unlike a corporation, an LLC isn’t required to have officers, a board of directors, or any of the administrative burdens typically associated with forming a corporation.

LLCs also provide a great deal of flexibility in terms of ownership and management. There are no restrictions on the minimum or maximum number of owners—also known as members—that an LLC may have. While many LLCs have only one member, they may have five, ten, or even hundreds of members.

LLCs may be managed by their owners, who are called members, which means that all owners share responsibility for the business's day-to-day operations. Additionally, LLCs have the option of appointing one or more managers to oversee the operation of the company. Managers may be members, nonmembers, or a mix of the two.

Additionally, LLCs have greater flexibility around their tax treatment. Generally, they are taxed as sole proprietorships or partnerships, but single-member LLCs and multi-member LLCs may elect to be taxed as a corporation instead of a sole proprietorship or partnership. You simply submit a form to the Internal Revenue Service (IRS) called an election. LLCs may elect to be taxed as a C Corporation or an S Corporation. In any case, the LLC owners are often considered to be employed by the companies. With C corporation taxation, the company pays corporate tax on its commercial earnings. The C company tax rate is 21%, much lower than most individual tax rates. With S corporation status, the LLC continues to be a pass-through company, with earnings passing through to the owners and being taxed at their individual rates. However, such payouts are not taxed under Social Security or Medicare. Thus, the tax status of S corporations may result in tax savings.

And lastly, forming an LLC helps your business appear more official and professional, which can vastly improve how your business appears to potential customers.

Disadvantages of an LLC

Even though the Limited Liability Company is a popular business structure with many advantages, there are a few drawbacks to forming an LLC.

The first disadvantage is that it’s usually more expensive to establish an LLC than it is to operate as a different business entity, such as a sole proprietor or partnership. To legally establish the LLC, filing fees must be paid for documents like your Articles of Organization. Once the LLC is established, the state requires yearly fees and taxes to be paid and since the LLC’s profits are considered personal income, they’re also subject to self-employment taxes. These vary by state but may reach upwards of $800 per year for very successful LLCs.

Although not required by law, it is also strongly recommended that LLCs establish a written LLC Operating Agreement. This is a document outlining whether the LLC is member or manager managed. Though there usually aren’t any fees associated with drafting an LLC Operating Agreement, it creates an extra layer of paperwork and administrative hassle in the early stages of establishing your business. An Operating Agreement also establishes procedures for how your LLC will conduct business, the shares of profits and losses, and the responsibilities of the LLC’s members or managers. It also typically includes procedures for redistributing ownership percentages if the amount of LLC members changes.

A Limited Liability Company can also make it much more difficult to find outside investors for your business. This is especially important if you are seeking financing from venture capitalists who would often only invest in companies. Corporations are the ideal vehicles for external investment since they may issue shares in return for investors' money. While outside investors may participate in LLCs and acquire LLC ownership interests, the process is more complex than it is with corporations.

Different Types of LLCs

In addition to the standard Limited Liability Company, there are specialized types of LLCs that you may be required to form depending on how you plan to conduct business.

Individuals engaged in certain kinds of professional activities are not permitted to establish standard LLCs in certain states. Instead, they must establish professional limited liability companies (PLLCs). These are Limited Liability Companies (LLCs) created specifically for licensed professions such as attorneys, physicians, architects, engineers, accountants, and chiropractors. The primary distinction between professional and ordinary LLCs is that professional LLCs need all members to have a professional license. Some states, such as California, do not allow a business offering professional services to form an LLC.

A Series LLC is an LLC whose Articles of Organization allow for the unrestricted division of membership interests, assets, and activities into distinct series. Each series works independently, having its own identity, bank account, and books and records. For instance, real estate owners who own several properties may use a series LLC. Each series isolates and shields its properties from the liabilities associated with other series' qualities. Additionally, businesses with distinct profit centers may utilize a series LLC to separate and protect each company activity. Only a few states permit series LLCs.

A single-member LLC is one controlled by a single individual. Single-member LLCs are permitted in every state. They are handled similarly to other LLCs, except they are disregarded as entities for tax purposes. This means that a single-member LLC is taxed as if the LLC did not exist, like a sole proprietor, and is still subject to certain excise taxes and employment tax.

Who Should Form an LLC?

Anyone who is starting a business or who is already operating a business as a sole proprietorship should consider creating an LLC. If you want to keep your own legal responsibility as low as possible and protect your personal assets, this is particularly important to consider.

LLCs are versatile business structures that may be utilized to own and operate virtually any kind of enterprise. However, in certain states, some kinds of professionals are required to establish a specific professional limited liability company (PLLCs). Any size business, from one-person enterprises to companies with many co-owners, may benefit from forming a limited liability company. Aside from that, an LLC is the most popular kind of business structure utilized to own rental and commercial property.

How To Form an LLC

The primary form you’ll be filing to start an LLC is the Articles of Organization, though the name of this document can vary from state to state.

While all states have different regulations, the general process of forming an LLC is similar. You will need to file the Articles of Organization with the state government where your LLC will be located, appoint a registered agent, register your business name, and typically establish an office address for your business.

A registered agent is an individual or business entity that agrees to accept service of process and other legal documents on behalf of your LLC. While you can act as your own registered agent in most states, doing so is often considered risky for your business.

You also may need to apply for an EIN (Employer Identification Number) from the IRS, register with your state’s tax agency, and file additional paperwork if your LLC is based in another state. Some states may require you to follow additional steps to the formation process. For example, Nebraska requires you to draft your own Certificate of Organization (equivalent to the Articles of Organization) instead of filling out a pre-made official form. Other states may have additional procedures as well.

How Much Does It Cost to Form an LLC?

The costs to form an LLC tend to vary. Generally, filing all the paperwork yourself can cost between $100 and $200, though there are some states with higher filing fees. Hiring a lawyer can cost more, but the most cost-effective option for business owners who want assistance with forming an LLC is to hire an LLC formation service. 

LLC Formation services can cost as little as $0 plus state filing fees, but they make the process of filing your paperwork much easier. Some LLC Formation Services even offer assistance with drafting your LLC Operating Agreement.

A Limited Liability Company (LLC) also has flexibility in choosing how it is taxed, which makes it a popular choice for business owners wanting to keep their tax expenses low.

Where Should You Form an LLC?

Now that we’ve reviewed the benefits of an LLC when compared with other business entities and discussed the basics of how to start an LLC, the next question is where should you form your LLC?

The laws, regulations, and even elements of the formation process vary from state to state. Some states have very simple and straightforward procedures and low start-up costs, others have extra steps and high filing fees. Some states impose LLC-specific taxes or have very strict business regulations. For specifics on a particular state, click on that state’s name in the list below:

In Summary

What is an LLC?

Now you know the definition of an LLC, how to start one, and the advantages and disadvantages of an LLC when compared with other business models. So congratulations! This is the first step to establishing your own LLC and beginning your journey as a small business owner.

If you’ve already established your business and wanted to know if restructuring your business into an LLC is right for you, then congratulations as well.

While traversing the sea of red tape, learning new legal jargon, and creating an LLC on your own may be a time-consuming process, completing it will be the first of many pleasant milestones on the path to establishing your own venture.

If you’ve decided to use an LLC formation service, my top recommendation is Northwest Registered Agent, which charges $39 plus state filing fees. Northwest Registered Agent is also my top recommendation for a registered agent service, offering exceptional quality for only $125 per year.

Good luck on your business adventures!

Leave a Comment