What are LLC Companies?

LLC companies, also known as limited liability companies, each have a corporate type of organization whereby the members within the business cannot be held liable on a personal level for the company's debts or liabilities. Limited liability companies combine qualities of a corporation and a sole proprietorship (partnership). Like a corporation, there is limited liability, but with the LLC the taxation structure flows to LLC members much like it would in a partnership.

Definitions: LLC, Company, and Limited Liability

  • LLC
    • Like corporations, a limited liability company or “LLC,” is a separate and distinct legal entity. This means that an LLC can get a tax identification number, open a bank account and do business, all under its own name.
  • Company
    • An entity formed to engage in business. A company may be organized in various ways for tax and financial liability purposes. The line of business the company is in will generally determine which business structure it chooses.
  • Limited Liability
    • Like corporations, LLCs guard their members against liability. Thus, members are not liable on a personal level for debts and frequently court decisions pertaining to the LLC.
    • Creditors are foreclosed from seeking the personal assets of the LLCs members. It is a meaningful shield not provided in a sole proprietorship or traditional partnership.
    • Unless you choose to be treated as a corporation for tax purposes, LLCs usually incur self-employment taxes. Thus, the LLC’s profits are not taxed at the corporate level, but instead go to its members, who capture the profits on their individual IRS tax forms. Often, these taxes are more than they would be from a corporate stance. Individual members will pay for federal items like Medicare and Social Security. Therefore, if you decide to commence an LLC, it’s wise to speak to a lawyer skilled in this area or accounting professional.

What is a Limited Liability Company?

For centuries, the choices for a business entity were one of these three: a sole proprietorship, partnership, and corporation. However, the LLC was invented in 1977 by Wyoming state to fill a new need—businesses that wanted to be organized and taxed like partnerships but gain protection from liability the way that a corporation does.

If you are thinking of crafting an LLC, you should first understand common LLC terminology, including:

  • Member – Someone who owns an interest in an LLC. Unless the articles of organization say differently, the member is the manager of the particular LLC.
  • Managing Member – A managing member is also an agent of the organization; he or she can enter into contracts on the LLC’s behalf.

Ownership Percentages

LLC ownership has two kinds of expression. Firstly, by percentage. Secondly, in terms of membership units; they are like corporate shares of stock. Either way, ownership brings with it voting rights and the right to profit share.

LLC Advantages and Disadvantages: An Overview

Before setting up an LLC, the organization’s owner should familiarize himself or herself with the LLC benefits and drawbacks, including those below.

Advantages of an LLC

There are several advantages to starting an LLC, but here are a few that stand out:

  • Pass-through taxes
  • Removes requirement to file a corporate tax return
  • Owners report profit share and loss on their own tax returns, so there’s no double taxation
  • No need for owners to be U.S. citizens or permanent residents
  • Legal protection. Owners have limited liability for business debts and obligation
  • More business credibility; from investors, partners, and suppliers after creating an LLC

Disadvantages of an LLC

Creating an LLC is attractive but there are some issues to overcome:

  • Growth potential has limits
  • No shares of stock to bring in investors
  • Different processes for LLCs between states
  • Earnings subject to self-employment tax
  • Tax recognition on assets that appreciate

These situations are possible if you make your business an LLC, so they are important to think about and discuss with relevant professionals. This is especially true given there is potential for extra taxation.

LLCs Compared to Corporations

LLCs and corporations are alike in enabling you to start a business without anxiety over unlimited liability. That being said, in creating LLCs, laws across the U.S. provide some rewards over corporations. For example, an LLC provides more flexibility and informal basis than a corporation, and the entities within an LLC can decide how it will be taxed.

Protections of a Corporation

Choosing an LLC as an ownership configuration is primarily to put a top on the principals' own liability. Usually, an LLC is considered a mix of a partnership (a basic business created from at least two owners, with a single agreement) with a corporation (having certain liability guards).

A corporation is more formal as a partnership arrangement, requiring Articles of Organization in the state to be completed and submitted. An LLC is simpler to enact versus a corporation and also is more flexible, along with better protections. That being said, creditors may be able to get harm the LLC if there is fraud or if legal or reporting guidelines aren’t met.

Less Paperwork

Compared with C-Corps or S-Corps, LLCs are very flexible. You’ll want to have an LLC Operating Agreement so you can create rules that govern your business. Otherwise, your company will be governed by the default rules in your state.

Confusion About Roles

While corporations have certain roles, such as directors, supervisors, and employees, LLCs typically do not. This can make it hard for people within the company and those investing in it to know who is at the helm, who signs contracts, and more. Avoiding this dilemma is possible with an LLC Operating Agreement.

Flexibility of a Partnership

A partnership is different than an LLC in that an LLC is created to detach one organization’s assets from the personal assets of the owner. Doing so protects each owner from being responsible for LLC debts and liabilities. An LLC functions like a partnership in that business profits end up showing on an owner’s own tax form. Losses can be used to counterbalance other streams of income, but it caps off at the amount being invested. The LLC itself fills out an informational tax return.

Regarding the business transfer or selling it, a business continuation agreement is necessary for the hassle-free handover of interests if an owner leaves or passes away. Without this specific agreement, an LLC must disband if forced into bankruptcy or a partner dies.

How Does an LLC Protect You?

Amongst the top benefits of an LLC is that its members (the proper word for owners) have "limited liability." This means under most circumstances they are not personally liable for LLC debts and liabilities.

If an LLC goes into bankruptcy, for instance, then the members will not usually have to pay the LLC's debts from their own pockets. If LLC assets don’t spread far enough to pay off debts and liabilities, the creditor companies typically won’t pursue the owners to pick up the balance. Their debt was with the LLC, not the owners of it.

Benefits of an LLC: Flexible, Scalable, and Simple

While LLCs don’t have the same harsh rules of corporations, they are as useful as corporations. Even if you’re the only member - or if you have many employees - an LLC guards you while allowing for scalability and progression. An LLC is free from required meetings, lengthy corporate records, and several other time-consuming guidelines.

Limited liability companies are even flexible when it comes to taxes. They offer lots of options so you can create a tax plan that works for you. The simple structure, protections, and accessibility make forming an LLC one that many U.S. small businesses seek.

Myths About LLCs:

  • An LLC is a "limited liability corporation" and identical to any corporation out there.
    • An LLC is a "limited liability company" and while it shares features with a corporation, it is not the same. For example, it has “members” not shareholders; the ownership style is different.
  • LLCs aren’t tax entities.
    • Most LLCs are taxed as sole proprietorships, meaning a single member, or partnerships (two or more participants). Certain kinds of LLCs can decide to be taxed as one of the available types of corporations.
      • An LLC is crafted with Articles of Organization, while a corporation is created using Articles of Incorporation. These articles have similar characteristics but are not interchangeable.
  • You can create an LLC in a state like Nevada and not pay income taxes.
    • While Nevada-based corporations are immune from income tax, a person cannot simply create a corporation in any U.S. state. You require a business “presence” or a tax nexus there, and you have to be carrying out business at that location. You must have an office or sell a product or service there, or have employees or facilities there. If you craft a Nevada-based LLC, for example, your yearly fees are $350.
      • The specifics differ between states. If your tax presence is in in California, for example, you must still have a California location for your LLC entity and pay the necessary state income tax and fees. While you might pay a bit less corporate income tax, your fee to maintain the company entity in the specific state is still required. Why not just follow the rules and incorporate in the state or states where you conduct most of your professional activities? Being underhanded usually ends up costing you more anyway.
  • An LLC is a tax entity.
    • No, it is not. How an LLC is taxed depends on how many members there are in the company.
      • A single-member LLC is taxed as a sole proprietorship; a multi-member LLC is taxed as a partnership An LLC can also elect to be taxes as a corporation.
  • LLCs are limited to small business.
    • LLCs are just as much for large businesses as for small businesses. Many large companies are LLCs, including Amazon and Chrysler.
  • LLCs have more risks than corporations.
    • There is good reason LLCs include the two words “limited liability.” A corporation is a separate entity, and its liability is separate from the liability of the owners unless something happens to “pierce the corporate veil” and then open owners and shareholders up to being sued.

An LLC reduces owner liability to their investment within the organization. Obviously, any company is vulnerable to being sued, and illegal activities are never condoned. If you have liability worries, talk to your attorney and insurance advisers.

Tax Flexibility

To the IRS, an LLC is not an unmistakable separate element for tax purposes. This implies, at any rate at first, the IRS won't impose the LLC straightforwardly. Instead, LLC members are able to decide how to be taxed. There are many choices:

  • Single member LLC
    • It is set up like a sole proprietorship when it comes to taxation. Benefits or misfortunes from the business are not exhausted specifically but rather are taxed through each member’s own tax return (federal).
  • Partners within an LLC
    • Members choose to be dealt with like a traditional partnership for the sake of taxes.
  • LLC filing as a Corporation
    • The individuals or “members” in the business may file as if in a corporation.

For the most part, individuals from an LLC will make an Operating Agreement that frameworks the way that the LLC will be dealt with for taxation purposes. Please note that the IRS automatically categorizes some LLCs as corporations. This system for particular LLCs is available at IRS.gov.

How to Form an LLC (Limited Liability Company)

  1. Choose a legal name and reserve it. Not all Secretary of State offices provide this service.
  2. Create and file your Articles of Incorporation with your Secretary of State.
  3. Choose who will oversee the business.
  4. Decide how many owners are in the business.
  5. Apply for a business license and other industry-specific certificates.
  6. File Form SS-4, or apply online at the IRS website to obtain an Employer Identification Number (EIN).
  7. Apply for any other ID numbers required by state and local agencies.

Regarding the final step (#7), requirements vary from one jurisdiction to another, but your business will most likely be required to pay unemployment, disability, and other payroll taxes. You will need tax ID numbers for those accounts in addition to your EIN.

Limited Life

In several jurisdictions, if a member leaves the LLC, the LLC no longer is active. This is different than a corporation whose identity is unaffected by shareholder activities. LLC participants can avoid this flaw in the Operating Agreement.

LLCs provide protection with a flexible structure. They safeguard members from personal liability while allowing them many tax opportunities. But, an LLC might not be a good fit for your business. Read our resources relating to each business type to make the best choice for your organization.

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