Limited LLC: Everything You Need to Know
A limited LLC, properly known as a "limited liability company" or "LLC," is one of the most popular legal classifications for a new business.4 min read
A limited LLC, properly known as a "limited liability company" or "LLC," is one of the most popular legal classifications for a new business. The owners of the LLC are called "members" and are protected from the business's liabilities, such as debt. LLCs are tied to the members' personal income taxes but are considered a separate legal entity.
How to Form an LLC
LLCs are considerably more flexible than a corporation, but this can be both an advantage and disadvantage. Depending on the state, LLCs must have a detailed operating agreement that specifies the following:
- Division of profit
- How management authority will work
- What management is responsible for
- Rights to withdraw capital
- Responsibilities to contribute new capital
An operating agreement can be very complex, so consider consulting with a lawyer.
What Is Ltd.?
"Ltd." stands for "limited" and denotes a company has the same limited liability protection as an LLC. Since it is a way to describe a business rather than a legal term, "ltd." can be attached to a C- or S-corporation.
Shareholders are not responsible for limited company debt. If the company becomes insolvent, shareholders' personal assets are protected, but their investment in the company is lost. Partners and owners are protected as well. The company is a separate legal entity and pays its own tax on profits. Shares can only belong to a small group, such as the founders.
In theory, limited companies are formed with an authorized share capital (the number of existing shares multiplied by their nominal value) and an issued share capital (the number of owned shares multiplied by their nominal value). Unissued shares can be issued by the director with permission of the shareholders at any time. Shares in a private company are usually traded via a private agreement.
Ltd. vs. LLC
A key reason for forming either entity is personal liability protection from the business's debts. An LLC's owners, called members, are all protected. However, in a Ltd. company, there must be at least one limited partner, who is protected, and one general partner, who is personally liable for the partnership's obligations.
The members of an LLC can either run the company themselves or hire managers. Each member is protected from liability regardless of how large or small a percentage of the company — called a membership interest — they own. In a limited partnership, the limited partner can not participate in business activities. If he/she does, then he/she may be liable for the business's activities.
A limited partnership is not taxed, and the profits and losses are shared by the partners and taxed only once. This may not be the case with an LLC, which can be taxed as a corporation rather than a partnership.
What the Law Says
"LLC" is a relatively recent designation, with most states' statutes enacted in the early 1990s. Therefore, there is a significant difference in case law regarding an LLC as opposed to a limited partnership. The law is still unclear as to what extent corporate law applies to an LLC.
Advantages of an LLC
An LLC has the following advantages:
- Members are not liable for business debts.
- The business is not taxed, but the net income is taxed as personal income.
- There are no membership restrictions. Foreign citizens can be members.
- LLCs enjoy a flexible tax status. By default, an LLC is taxed as a sole proprietorship or partnership, but it can choose to be taxed as a C- or S-corporation
- LLCs offer flexible profit sharing. An LLC's profits can be divided among members irrespective of the size of their membership interest
- There are limited mandated annual filing requirements for LLCs. While a corporation must have an annual meeting of directors and shareholders, keep minutes of meetings, keep records of all formal resolutions, and adopt bylaws, an LLC may have meetings whenever it wishes and document things however it wishes. LLCs are not required to do either, however.
Disadvantages of an LLC
LLCs have the following disadvantages:
- You must pay self-employment tax. Often the personal income tax of LLC members is higher than corporate taxes.
- You must keep careful, separate records of your business expenses.
- If a member leaves an LLC, the LLC typically dissolves.
- You'll need separate business and personal bank accounts. Banks usually have different fees for business accounts and often charge extra for business account deposits. A check made out to your LLC cannot simply be cashed but must be deposited into your business bank account.
Business law is complicated, so you might want to talk to a business attorney.
If you need help establishing your business as a limited liability company, or 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.