Define LLC: Everything You Need to Know
An LLC can also convert to a C corporation in order to pursue new investment opportunities. Here, we've highlighted essential information about LLCs.3 min read
The IRS defines an LLC based on its tax structure — either as a partnership or disregarded entity. An LLC can also convert to a C corporation in order to pursue new investment opportunities. Here, we've highlighted essential information about LLCs.
Why Form an LLC?
When business owners start an enterprise, they may choose to form an LLC. This structure combines the benefits of sole proprietorship with a few perks of a corporation. An individual or several partners may form an LLC for the following reasons:
- Tax advantages: An LLC receives what is known as “pass-through taxation.” Only the members are taxed rather than the business and its owners. Sole proprietorships enjoy this benefit as well.
- Limited liability: LLCs also enjoy limited liability, like a corporation. If an LLC declares bankruptcy or is sued, the members' personal assets are protected. LLCs also receive their own tax identification number, which allows the owners to open bank accounts and conduct similar business matters using the LLC's name.
- Profit distribution flexibility: LLC members can also select whichever form of profit distribution that they prefer. Unlike a corporation, this doesn't account for the ratio of ownership between the LLC members. Corporations are also required to hold board and stakeholder meetings, to record the minutes of those meetings, and more. An LLC doesn't have to meet these standards.
- More options for their daily business operations: LLCs can select different classes and different rights for their company stock. For comparison, S corporations only have access to one class of stock. Moreover, LLCs can work with an unlimited number of individuals, corporations, and partnerships. S corporations are limited to 75.
What Is Required to Form an LLC?
An LLC requires the creation of “Articles of Organization”, a document stating the business's name, the names of its members, and other basic information. This document is known as a “Certificate of Organization” or a “Certificate of Formation” in certain states. There's also a filing fee, which varies based on location.
Moreover, some states require that you publish in the local newspaper an announcement sharing your formation of an LLC. This is called “publishing an intention.”
You may also draft an operating agreement. Though not required in all states, this document outlines the roles and responsibilities of all LLC members. This can help with any legal disputes down the road.
Disadvantages of an LLC
One drawback of LLCs is that ownership interests are only transferable under certain conditions. LLCs also usually dissolve when a member dies or if the company files bankruptcy. Moreover, investment options are limited for LLCs. This type of business can't go public, so it can't offer shares or stock options as a benefit to employees or to attract new investors.
Finally, the paperwork required to form an LLC is a bit more complex than what's needed for a sole proprietorship. Of course, it's also considerably simpler to form an LLC than it is to form a corporation.
Common LLC Terms
Familiarize yourself with a few LLC terms to learn more about how these businesses operate:
- Member: The individuals who own an interest in an LLC are known as “members.”
- Managing member: The members can set up the LLC so that one “managing member” runs the business' daily operations.
- Registered agent: The “registered agent” is a liaison for the company. This person is authorized to accept service of legal papers on behalf of the LLC and send them to the members. The members appoint the registered agent when forming the company. This individual can be one of the members or someone else.
- Articles of Organization: The LLC members file “Articles of Organization,” also known in some states as a “Certificate of Organization,” with the Secretary of State. This document contains basic information about the company.
Types of LLCs
For tax purposes, there are three types of LLCs:
- Sole proprietorship: Single-member LLCs are known as “sole proprietorships.”
- Partnership: A partnership LLC is one with two or more members.
- Corporation: LLCs can convert to a C corporation if they're interested in attracting investors by offering equity or issuing shares to employees.
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