What Is an LLC?

Forming an LLC provides certain tax protections. Your business is still tied to your personal taxes, but you file all business expenses as deductions.

A limited liability company, or LLC, is a type of private company that is formed to reduce the personal liability of the owners. Since it first became available as an option, the LLC, or Limited Liability Company, has been increasingly attractive to entrepreneurs due to the protections it offers. It's much simpler to set up and much more flexible than a traditional corporation, but it still provides a liability and tax shelter in terms of protection of your personal assets. It's the best of both worlds for people seeking the protections of incorporation with the simplicity of a sole proprietorship

How LLCs Work

When you file an LLC, you are a member of the company, and you can be the only member or there can be multiple members, depending on the paperwork you file, called the Articles of Incorporation. 

An LLC is set up by filing an operating agreement, and this document governs everything about the company. It has all the information related to ownership, the process for adding and removing members, what happens if a member becomes incapacitated, and how the company is governed. This document is internal and is not recorded with the state. 

LLCs are ideal for those who aren't planning on soliciting investors for their business; those who need to protect personal assets; and those who need flexibility in business operations. LLCs are outstanding for sole proprietors, partnerships, or small multiple-member companies who need the limited liability protection provided to corporations but without the complex formalities that go along with traditional structures. 

Who Cannot Be an LLC?

Certain companies don't have the ability to become an LLC. These include financial trust companies, insurance companies, and other financial businesses. In California, architects, accountants, and licensed healthcare providers can't be LLCs. Other states may have their own restrictions on who can and cannot register an LLC. You should first check with your state's small business office to decide if your business is eligible. 

Advantages of This Kind of Business

There are many advantages to forming an LLC. The biggest is that it's flexible and easy to set up. You gain limited liability protection, which means that only the company has liability for any debts or damages incurred. Your personal assets and those of any other members are protected and separate from the company. 

Pass through taxation is another advantage. Rather than the company paying the taxes, all income and losses pass on to the owners' and members' personal income taxes. This is very similar to a sole proprietorship or partnership. This tax status is also very versatile. By default, it's a partnership or sole proprietor depending on the number of members, but if the members decide, it can be taxed as a standard corporation as well. 

There is no restriction on ownership of an LLC related to citizenship or residency. That means foreign nationals can own an LLC, and even corporate entities can be members or even the only member. There are also limited requirements for formalities and annual filing. Unlike corporations, LLCs don't have to hold annual shareholder meetings, adopt bylaws, or keep minutes. There's no requirement for board votes on resolutions or minutes to be kept. 

Finally, profit distribution is very flexible in an LLC. Members can divide profits and earnings in any way they choose and distribute as they see fit. Other corporations require profit-sharing based on ownership percentages. 

Disadvantages of This Kind of Business

There are, however, downsides to forming an LLC, which include the need to pay self-employment taxes. This means you pay more taxes than other kinds of business, including social security and Medicare. 

You also need to keep very careful records to make sure your business activities stay separate from your personal finances. Should the time come to take advantage of the protections an LLC offers, you need to track business expenses accurately. This requires a business checking account, which carries a different fee and monthly expense schedule than a personal account. Any money paid to your LLC has to be deposited to your business bank account. 

There's also the danger of termination of an LLC, should a member decide to leave. Unlike a regular corporation, an LLC only remains solvent if all members are on board. That means if you have a falling out with one of your partners and they quit, your LLC may dissolve and have to be reformed as a new company. This, in some ways, can be managed by your governing document, but again, it can create complications. 

Protecting Your Assets

Limited liability protection is the single largest reason many people file an LLC. In this form, assets owned by the company are separate from those owned by the company's members. This means if there is a lawsuit against the company, the members' assets cannot be targeted. Likewise, any debts or problems faced by the company don't transfer to the members. 

The only thing the members of an LLC stand to lose is what they invested in the company, the initial investments plus retained earnings from the company. It's not much different from owning stock in a company that suffers a loss. The most you lose is the value of the stock you bought. 

LLC Membership

In legal terms, the members of an LLC are the same as the owners. LLCs can have employees, but they are not members. 

Members of an LLC are the beginning and end of authority for the company. They are responsible for managing all aspects of the company. There are no distinct positions like directors, officers, or shareholders. 

Each member of the LLC fills all the roles at all times, though they may agree in their governing documents to split responsibilities. Usually, ownership is expressed as a percentage and not in terms of stock shares. So Mark might own 30 percent while Susie owns 50 percent and Alex owns 20 percent. Again, this is based on divisions set up during the filing of ownership papers. 

Changing an LLC

LLCs can change, but doing so requires filing amendment paperwork with your secretary of state. Not every change you make requires this paperwork, but in general, anything that modifies the articles of incorporation or organization of your company has to be filed with the state government. 

Types of LLC

There are different types of LLC. These include: 

  • Domestic: LLCs that operate and form within a state, where the state has governing authority
  • Foreign: Where LLCs operate in a different state than the one in which they form. Some LLCs are, for example, formed in Delaware due to tax laws there but operate out of state.
  • Member-Managed: Where all members share equal management of the company. This is the most commonly found form of LLC.
  • Manager-Managed: Where one or more partners remain "silent" and "passive" and one or more have more delegated management responsibilities
  • Single-Member: An LLC that has only one member
  • Multiple-Member: An LLC with two or more members. These require careful wording of operating agreements to account for the folding of the company or members leaving.
  • Series: A unique type of LLC that is the master company of a number of other legal entities, assets, or interests. This LLC is only available in Utah, Texas, Tennessee, Oklahoma, Nevada, Iowa, Illinois, and Delaware.
  • Restricted: This kind of LLC is available only in Nevada and is restricted from making certain distributions for the first 10 years of formation.
  • L3C: This is a for-profit company which operates on philanthropic social principles. It provides the protections and flexibility of an LLC with the benefits of a nonprofit and the marketing advantages of an enterprise.
  • Anonymous: This is a company whose membership is not made public by the state. Very few states allow for this kind of company. New Mexico is one that does.

Forming an LLC

Forming an LLC isn't a difficult process. You first need to decide what you want to do, how your company will operate, and what you want to call it. You want to search state and possibly national records to make sure that no one else has registered your name. So long as nobody else is using the name, you can call it whatever you like. However, you must always use the designation, LLC or L.L.C. after your business name. Some states have restricted or prohibited words you can't use. Check with your state's business office for more information. 

When this done, you need to file articles of organization with your secretary of state's office. This is a brief form that lists the members of the LLC, as well as their contact information. Some states have other requirements, so check with your state's small business office or secretary of state's office to make sure you have all the paperwork you need. The registration fees to set up an LLC range from $30 up to $200, plus any legal fees you incur during the process. 

The paperwork must be filed by a registered agent who lives in the state where the LLC is registered. This person serves as the business' representative for receiving legal correspondence. This agent may not use a P.O. box in most states and must have a physical address. You can serve as your own registered agent, or you can use a service. 

Next, you should work up an operating agreement that lays out ownership percentages, rights, roles, and responsibilities of each member. This agreement allows you to protect your company should any court challenges or disagreements arise among members.

Third, you need to acquire a tax number, or EIN, for your business. This allows you to conduct business and serves the same purpose for taxes as your social security number does for your personal taxes. You also want to note any administrative fees that your state charges, which could reduce the tax advantages for your new company. California, for instance, charges an annual $800 LLC tax along with a $900 to $11,760 annual fee based on a business's total annual income exceeding $250,000.

You also need to check to see if your desired LLC name is available. This will allow you to register a domain name. You should do this even if you aren't currently planning on building a website. Reserving your domain name will prevent others from using it and undercutting your business.

LLCs and Publication

Some states, though not all, require an LLC's formation to be published. This is only a requirement in Nebraska, New York, and Alaska. New York requires the formation to be published in two different NY newspapers, and proof of publication has to be filed with the state within 120 days of formation. Failure to do so can result in the suspension of a company's right to do business.

Licenses and Permits

Some states may have specific rules and laws related to the permits and licenses you need to operate. These vary not only by state but by business. For example, an attorney is licensed by your state bar, but publishing on-demand books out of your house may not require any special permits. Check your state and local statutes to make sure you're covered before you start your business.

Hiring an attorney isn't required to form an LLC, but a lawyer can be very helpful in navigating the specifics of a state's individual regulations. At UpCounsel, we offer a thorough database of the top attorneys in the field, who attended institutes like Stanford, Harvard, and Yale, and have outstanding reputations. If you're in need of a business formation attorney or any other resources for starting a business in your state, post your job today.