LLC Entity Explained: Benefits, Types & Formation
Learn what an LLC entity is, its advantages, disadvantages, types, and formation steps to decide if it’s the right structure for your business. 6 min read updated on August 12, 2025
Key Takeaways
- An LLC entity combines the liability protection of a corporation with the tax flexibility of a partnership or sole proprietorship.
- Benefits include limited liability, pass-through taxation, and flexible ownership and profit distribution.
- Drawbacks can involve self-employment taxes, stricter recordkeeping to maintain liability protection, and possible dissolution upon member departure.
- LLCs come in various forms, such as single-member, multi-member, series LLCs, and L3Cs.
- Forming an LLC involves steps like selecting a state, appointing a registered agent, filing formation documents, creating an operating agreement, and complying with ongoing requirements.
- LLCs differ from corporations in taxation, management structure, and formalities, making them more flexible but sometimes less attractive to certain investors.
What is an LLC?
An LLC entity, or more plainly, a limited liability company, is one of the main business types one can choose to run their business as. An LLC entity is often described as a hybrid business entity since it borrows the taxation advantages and flexibility of partnerships along with the liability protections of corporations. Taken together, these features help to form a business entity that has great appeal to small business owners and entrepreneurs.
How to Form an LLC Entity
Forming an LLC entity typically involves several steps, which vary slightly by state:
- Choose a state – Many businesses form in their home state, but some choose states with favorable laws or lower fees.
- Select a name – The name must comply with state rules, usually requiring “LLC” in the title and avoiding restricted terms.
- Appoint a registered agent – This person or company receives legal and official documents on behalf of the LLC.
- File Articles of Organization – Also called a Certificate of Formation, this document is filed with the state and includes key details like the LLC’s name, address, and members.
- Create an operating agreement – While not always required, this document outlines the ownership, roles, and operating procedures of the LLC.
- Obtain necessary licenses and permits – Local, state, and federal requirements vary by industry and location.
- Apply for an EIN – An Employer Identification Number from the IRS is needed for hiring employees, opening a bank account, and filing taxes.
- Comply with ongoing requirements – This can include annual reports, fees, and maintaining a registered agent.
LLC Advantages
There are many advantages to running your company as an LLC. Some of them include:
- Limited liability protection. This means that in most cases, your personal assets will not be at risk due to business-related debts or legal issues. Only what interests you have invested in your business will be up for grabs. However, some transgressions, such as fraud, may not be covered by limited liability.
- Pass-through taxation. For LLCs, profits and losses are not paid on the business taxation level, but passed through to the personal taxes of the LLC members. This allows LLC members to avoid the double-taxation of corporations.
- Unrestricted ownership. Unlike corporations, LLCs do not have citizenship or residency restrictions. Additionally, business entities, such as corporations, partnerships, and LLCs, may be LLC owners.
- Versatile taxation. Because the IRS does not recognize the LLC as a tax classification, LLCs can choose how they will be taxed, whether as a sole proprietorship, partnership, C corporation, or S corporation.
- Versatile profit distribution. LLC members are not required to have their LLC profits distributed in proportions equal to their investment. If they so choose, they can arrange a different distribution model. In contrast, corporations are locked into a proportional distribution model.
- Few compliance requirements. LLCs have few state filing requirements or operational formalities, while corporations must have at least one annual meeting of the board of directors, keep minutes of that meeting and any other meetings, and adopt bylaws. LLCs have no meeting minutes, or bylaw requirements.
Additional LLC Benefits for Business Owners
In addition to standard advantages, LLC entities offer:
- Investor flexibility – LLCs can admit new members more easily than corporations can issue stock.
- Credibility boost – Using “LLC” in the business name can improve perceived legitimacy with clients, suppliers, and lenders.
- Fewer residency restrictions – LLC owners can reside anywhere in the world, unlike certain corporate structures.
- Flexible accounting methods – LLCs can choose cash or accrual accounting, depending on operational needs.
LLC Disadvantages
Despite the many advantages of LLCs, they do have some disadvantages. Such disadvantages include:
- Self-employment taxes. LLC members must pay FICA taxes (Medicare and Social Security taxes). Because of this, in some situations, taxes for LLC members may end up being higher than corporate shareholder taxes, even with pass-through taxation. You may want to consult with an accountant to figure out which tax method is best for you.
- Greater responsibility for personal records. It is of the utmost importance for an LLC owner to keep their business finances separate from their personal finances. If this is not done, limited liability cannot be ensured.
- Possibility of LLC termination. In most cases, if a member leaves the LLC, the LLC will be terminated. Corporations, in contrast, exist regardless of individual shareholder membership.
- Banking requirements. An LLC owner will have to set up a separate bank account for their business in order to keep their personal and business finances separate. There will usually be a number of monthly bank fees for keeping this type of account.
Common Misconceptions About LLC Entities
Some business owners overestimate LLC protections. While LLCs provide limited liability, courts can “pierce the corporate veil” if owners mix personal and business finances or engage in misconduct.Other misconceptions include:
- Automatic tax savings – While pass-through taxation avoids double taxation, self-employment taxes can be significant.
- Lifetime existence – Some LLCs dissolve when a member departs unless otherwise stated in the operating agreement.
- Uniform rules nationwide – State laws differ widely on LLC operation and compliance.
LLC Types
There are many different types of LLCs, each with their advantages and disadvantages. These LLC types are as follows:
- Domestic LLC. This is an LLC that was formed in the home state of its owner and operated in that same state. The home state has governing jurisdiction over this LLC.
- Foreign LLC. This refers to an LLC that operates in a state other than the one it was formed in. So if an LLC was formed in Nebraska but was operating in California, California would consider it a foreign LLC.
- Member-managed LLC. This is an LLC in which the members handle the day-to-day operations of the business. This type of LLC is the most common.
- Manager-managed LLC. In this LLC, the management of the business is done by managers, who are often brought in from outside the LLC. This type of LLC is favored by those who would prefer not to deal with day-to-day business issues.
- Single-member LLC. An LLC with one member.
- Multi-member LLC. An LLC with multiple members.
- Series LLC. An LLC that holds a number of smaller entities under it, all of which are considered separate from a legal standpoint. Only eight states allow the series LLC at this time.
- Restricted LLC. Available only in Nevada, this type of LLC restricts some types of business distributions to 10 years after LLC formation.
- L3C. This is a for-profit company with a philanthropic purpose. It combines the tax and legal advantages of an LLC with the social advantages of a nonprofit.
LLC vs. Corporation: Key Differences
While both LLCs and corporations protect owners from personal liability, they differ in:
- Taxation – LLCs enjoy pass-through taxation unless electing corporate tax status, while C corporations face double taxation.
- Management – LLCs can be member-managed or manager-managed, while corporations must have a board of directors and officers.
- Formalities – Corporations must hold annual meetings and maintain bylaws; LLCs have fewer required formalities.
- Ownership structure – Corporations issue shares of stock, while LLC ownership is expressed as membership interests.
Frequently Asked Questions
-
Is an LLC entity the same as a corporation?
No. While both offer liability protection, LLCs have more flexible management and tax structures than corporations. -
How much does it cost to form an LLC entity?
Costs vary by state but generally range from $50 to $500 for filing fees, plus any ongoing annual fees. -
Can a single person own an LLC?
Yes. A single-member LLC is allowed in all states and offers the same liability protection as multi-member LLCs. -
Do I need an attorney to form an LLC entity?
While not required, an attorney can help ensure compliance with state laws and create a strong operating agreement. -
How is an LLC taxed by default?
By default, single-member LLCs are taxed as sole proprietorships, and multi-member LLCs are taxed as partnerships unless they elect corporate taxation.
If you need further help understanding LLC entities, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5-percent of lawyers. 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.