LLC: Introduction

Do I need an LLC? An LLC, or limited liability company, is a legal business entity in which an individual's personal assets are protected from business-related lawsuits and debts. New businesses must decide to form as either an LLC, a C corporation, or an S corporation. An LLC is often the ideal choice for small business owners. Adding "Limited Liability Company" or "LLC" to the name of your business adds a certain level of respectability and prestige. Many new business owners also need to obtain licenses to operate in their state or municipality. The process of creating an LLC is fairly straightforward, but you may want to consult an attorney to determine whether this is the best business entity for your situation.

LLC: Definition

An LLC blends benefits of a partnership with those of a corporation. As with a corporation, LLC owners (also called members) receive interest in the company in exchange for their services, money, or property. When you operate an LLC, your personal assets are considered separate from business assets in most states. This makes it a popular business structure for sole proprietors or partners who want to protect their individual property from business liability.

The LLC structure also protects LLC owners and partners from double taxation. Revenue from the LLC is filed on the business owner's individual income tax return; the income "passes through" the LLC and is considered self-employment tax, avoiding taxation at the higher corporate rate.

It's easy for sole proprietors to prepare their tax returns with an LLC. They must file Schedule SE and Schedule C along with the individual tax return. LLCs with more than one member have a few more steps to follow. Each LLC owner must file Form 1065, which is a partnership return, along with a Schedule K-1 for each LLC member. This document shows how the business's credits, profits, and losses are allocated. 

An LLC can have any number of owners and can be created regardless of income. However, this structure has implications for the business's receipt and distribution of income. The LLC is recognized by the IRS as its own taxable legal structure, and can opt to file taxes as a partnership, S corporation, or sole proprietorship. Many LLC owners opt to file taxes in their home states to streamline the process and avoid paying franchise taxes. You can access additional benefits for taxation as well as estate planning by putting your LLC in a living trust.

How to Establish a Limited Liability Company

Each state has its own regulations for LLC formation. In general, you'll have to file Articles of Organization along with the state filing fees to create your LLC. These fees vary by state but are about $200. Once your LLC is official, you should create an official operating agreement along with bylaws. Like a partnership agreement, an operating agreement details the day-to-day management of the business. If you do not create an operating agreement, you'll be subject to the default rules of your state.

It's important to understand and abide by your state laws about LLC operation. Your limited liability protection is invalidated if you are found to have engaged in any type of misrepresentation or fraud.

Reasons to Create an LLC

A sole proprietor has three key reasons to form an LLC:

  • The limited liability coverage afforded by this business structure.
  • The tax benefits of filing as a pass-through entity. Corporate profit is taxed at the 35-percent corporate rate, then taxed again at 15 percent when dividends are distributed. In contrast, LLC profits are only taxed once, at the lower individual rate.
  • The ability to draw a regular paycheck throughout the year. You can have taxes withheld to avoid a large bill at the end of the year. In addition, your paycheck is an expense that can be deducted from the business taxes, reducing the amount you'll pay in self-employment tax.

Federally Licensed Businesses

Some businesses must apply for federal licenses, typically those engaged in interstate commerce. Other categories that are federally regulated include companies in aviation, agriculture, alcohol, fish and wildlife, firearms and weapons, maritime transportation, nuclear energy, mining, drilling, and broadcasting.

If you need help with establishing an LLC, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.