To understand how an LLC works, you'll have to know how the business is managed and taxed. You should be familiar with how the business handles profits and losses and who runs day-to-day operations.

How Does a Limited Liability Company Work?

Many small business owners prefer the limited liability company (LLC) structure because it gives them the liability protection that corporations enjoy but without all the formalities and the double taxation.

LLCs are often cast as a simple and quick alternative to incorporation. They're also viewed as a safe alternative to partnerships and sole proprietorships. It's still very important to understand how LLCs work before forming one.

You can form an LLC by filing formation documents with your state. In your documents, you and any other owners, or members, will specify how your company will be managed. You may choose "member-managed," where the members manage the business. You might also select “manager-managed,” where one or more people — inside or outside of the company — will be chosen to manage the business.

In member-managed LLCs, all of the business's owners can take part in daily operations. In a manager-managed LLC, only the appointed managers take part in the day-to-day business operations.

Similar to a corporation's charter, an LLC has an Articles of Organization. This document establishes the company as a separate legal entity. It also contains important information about the LLC, such as the following:

  • The owners
  • The business address
  • The managers
  • The sole proprietorships and partnerships to stop operating, but the dissolution of LLCs can be more complicated. The operating agreement will outline what happens in the case of dissolution, including details for the following:
    • How to distribute the business's assets among members
    • How to compensate members for any business debts they personally guaranteed
    • How to return capital contributions

    Main Features of an LLC

    Until the LLC business structure was created, business owners were personally responsible for business debts unless they incorporated. LLC owners have personal liability protection against business debts, such as legal settlements or court judgments. Business owners are only at risk of losing the amount of money they put into the business to start it. This doesn't apply, however, if an owner personally guarantees a loan, in which case the owner is personally liable for that debt.

    LLCs are generally treated like partnerships for tax purposes, and this applies to how profits and losses are handled. Like a partnership, an LLC is considered a “pass-through” entity by the IRS. However, you may choose to be taxed differently. Some LLC owners choose to be taxed like corporations because it results in lower taxes.

    If you don't elect corporate tax treatment, your business's profits or losses are not taxed at the business level. Instead, they pass through the business to the individual members. Members then report and pay taxes on their share on their personal tax return.

    LLCs are considered the easiest business structure to form. Many people can set up an LLC in a very short period of time, and it's possible to do it without an attorney. If, however, you need assistance understanding all of the guidelines in setting up an LLC, you should consider consulting with legal and tax professionals to ensure you meet all the necessary requirements.

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