When researching info on LLC, you will find that a limited liability corporation is a type of business entity that creates a separation between the business and the owner, thus protecting them from liability for business debts. An LLC is also a sought-after entity because unlike a corporation, an LLC utilizes "pass-through" taxation, eliminating the double taxation penalty. Taxes are paid at the personal income tax level by its members.

Creating and running an LLC is much less complex and requires significantly less paperwork than a corporation. Most business owners choose an LLC entity for tax purposes, liability protection, and flexibility with its management structure.

LLC Formation and Operation

You will need to follow multiple steps when forming an LLC. To have your business accepted as an LLC, you must:

  • File your company's articles of organization with your state's Secretary of State office. The Articles of Organization should include your business name and the name and addresses of each of its members.
  • Choose a business name that is unique from any other business name registered in the state. You can search your desired name in your state's database to ensure it is available.
  • Create an operating agreement that defines the internal rules for the management of the business. While these agreements are not necessary, they are recommended. The operating agreement may vary in its complexity depending on the size of the company and the management structure.

Limited Personal Liability of an LLC

In an LLC, shareholders are protected from business liability and debt, similar to the protection provided by a corporation. If a business cannot pay its debts, shareholders are not required to use their personal assets to cover the business debt. If an LLC fails, members can only lose the amount of money they invested in the company. This practice is referred to as limited liability.

Exceptions to Limited Liability of an LLC

Even though members of an LLC are able to benefit from not having personal liability for business debts, limited liability includes some exceptions. Some situations in which personal liability may occur in an LLC are:

  • You personally killed or caused direct injuries to someone.
  • You signed a personal guarantee for a bank loan.
  • You failed to deposit withholding taxes for employees.
  • You intentionally performed fraudulent, illegal, or reckless activities to someone or the company itself.
  • You used the LLC for personal affairs instead of operating it as a separate entity. If this occurs, a court may in effect rule that the LLC does not exist, so it is important to keep personal and business accounts and affairs separate.

Business Insurance Can Provide Additional Protection for LLCs

For additional protection for your LLC, a good business insurance policy can defend your assets in the event your limited liability does not protect you. Insurance can also protect your assets if a court disregards your LLC status in a civil suit. Although commercial insurance does provide you with protection from lawsuits, it does not protect you from business debts that go unpaid. If you have a personal guarantee, your assets can still be sought.

LLC Taxation

An LLC is a disregarded entity by the IRS, so you will have to elect your IRS business entity designation. If your LLC has two or more members, you can choose to have the business taxed as a partnership or corporation. One-member LLCs file taxes as sole proprietorships.

Unlike members of a corporation, members of an LLC only pay taxes on the profits they receive from the business. LLC members can choose to reduce some of their tax liability by putting the profits back into the business. An LLC is not considered a separate business when it comes to taxation, and it will function as a "pass-through" tax entity, taxing at the member level through their personal return.

If you are an LLC member, you will need to make quarterly tax payments to the IRS and file an informational Form 1065, which along with Schedule K-1, describes each member's portion of the business so they can correctly report their share of profits and losses on their personal income tax form.

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