Explain LLC: Everything You Need to Know
The simplest way to explain LLC is that it combines some of the characteristics of a corporation and a sole proprietorship or a partnership.3 min read
2. Advantages of Starting an LLC
3. Disadvantages of Starting An LLC
The simplest way to explain LLC (also known as a limited liability company) is that it combines some of the characteristics of a corporation and a sole proprietorship or a partnership. In some ways, it combines the benefits of these other business structures. That is why many small businesses choose to form an LLC. Like a corporation, an LLC gives business owners limited liability protection, while it also allows the company's profits and losses to pass-through to the LLC members. An LLC:
- is one of the business structures available to business owners. It gives LLC members limited liability treatment and allows the LLC members to file revenues and losses on their personal tax return.
- has some advantages over other business types because it is flexible, it does not pay income tax at the entity level, and offers some protection to LLC members through limited-liability protection.
- offers LLC members the flexibility of running the business as they see fit. They decide profit distribution and management authority.
- does come with some disadvantages. For instance, there are limitations on how members can transfer ownership.
Limited Liability Company or LLC Basics
Comparable to a corporation, an LLC is a separate entity from its members. Just like a person, an LLC:
- can have its own tax identification number (known as an Employer Identification number or EIN).
- can open financial accounts, such as a bank account.
- is liable to its creditors. A creditor cannot seize a member's personal assets to satisfy a business debt.
- can make business deals and make transactions.
An LLC business structure gives its members protection. LLC members are generally not personally responsible for satisfying the business debt and liabilities. LLCs are hybrids of other types of business entities. It combines the characteristics of a corporate entity and a partnership or sole proprietorship. The limited liability attribute is like a corporate entity, while the flow-through taxation to the LLC members aspect derives from a partnership business structure.
Advantages of Starting an LLC
There are several advantages to forming an LLC, and one primary advantage is the ability for owners to decide business management authority and profit distributions. For example, an LLC member can invest 10 percent of the startup funds and keep all the management authority and most of the profits.
Another major advantage of starting an LLC is that it passes through taxes to its members. This means you do not file a corporate tax return. Instead, each member reports their profits and losses on their individual tax returns. Therefore, LLC's avoid the standard double taxation that a C corporation experiences.
Additionally, LLCs have the flexibility to decide whether they want the IRS to view them as a corporation or a partnership. If you want to take advantage of corporate taxation, file a Form 8832, Tax Classification. Consult with your accountant or your tax advisor to see what election is best for your small business.
Also, an LLC structure protects its member assets, business debt, and liabilities. All things being equal, if an LLC files bankruptcy, the LLC members should not have to pay the debt from their personal funds.
Non-citizens can create an LLC. Given that fact, it allows business owners the chance to create a business structure that partners, suppliers, and lenders find credible.
Disadvantages of Starting An LLC
LLCs cannot issue stock. If your business relies on outside investors, then you may want to reconsider forming an LLC. This is only an issue if you need outside investors.
Unfortunately, LLCs treatment varies from state-to-state, offering no consistency in the way they are formed. This is because the LLC structure is relatively new. Federal and state governments want more restrictions on current LLC guidelines. Changes to the LLC structure is not only possible, it's seemingly inevitable.
If you are considering an LLC, compare the advantages and disadvantages based on your business needs. Contact your Secretary of State's office to find out what you need to do to form an LLC. The LLC business structure is still in its infancy and is under regulatory scrutiny. Consult with your legal and tax advisor to stay up-to-date with the latest guidelines.
If you need someone to explain how LLCs work, 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.