LLC examples help illustrate the various business structures available to entrepreneurs.

What Is the Common Business Structure for New Entrepreneurs?

First-time business owners sometimes struggle with deciding on how to structure their business. A sole proprietorship is the most common and simplest structure selected to start a business.

Advantages of LLC

The LLC business structure combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation, creating the best of both worlds for business owners. First-time business owners often recognize the benefits of this business structure, such as tax advantages, business deductions, personal liability protection, income tracking, and the fact that LLCs don't pay business taxes.

Self-Employment and LLC Examples

Limited liabilities companies have many benefits. Many small business owners find that LLCs are easier for taxes, income tracking, lawsuits, and business write-offs.

Taxes and LLCs

LLCs do not pay taxes as entities. LLCs are pass-through structures, which means that taxes are sent instead to the members. The owner(s) needs to pay all the taxes the LLC profits, and consequently, ought to make quarterly payments. The owner should pay normal income tax, as well as self-employment tax.

Tracking Income

Ensure that all checks for the LLC are made out to the LLC's name. For expenses, checks should be written from the LLC's account. It is important to track income for preparing the LLC's profit and loss statement. The owner is able to pay themselves anytime. The owner can just write a check from the LLC to themselves. The two-tiered tracking method permits strong business accounting, as well as unlimited payments to themselves or other LLC members. The company's accounting ledger tracks all LLC expenses.

Business Write-Offs

An LLC can write off many expenses that an individual can't do so themselves. However, the owner can't write off their own car on their taxes. Rather, the LLC can own a car. The LLC can depreciate it yearly and, therefore, lower its reported net income. When the income passes through to the members, the car expense will already be deducted.

Lawsuits and Accidents

A self-employed person needs to work hard in order to build their own assets and those for their family. The LLC's owner has no personal liability for the company's mistakes.

Definition of Liability

Liability means being legally responsible for a matter.

Limited Liability Company

A limited liability company (LLC) is a private legal entity in the U.S. that mixes corporate limited personal liability with partnership and sole proprietorship's simplified taxation. The LLC's owners put the company's profits and losses on their individual tax returns (pass-through taxation) instead of an LLC corporate tax return. LLC owners are called members. The LLC can be owned by just one person, two or more people, by a corporation, or by another LLC.

The LLC's members are not held personally liable for the business' obligations. If the business can't pay its obligations (rent, loan payments, business suppliers, etc.), creditors can only pursue the LLC's assets. The LLC's members risk only losing the capital they have put into the business, protecting their personal assets (home, car, etc.).

Exceptions to Limitation of Liability

However, LLC members are not given total protection against liability. LLC members can be held personally liable just like corporate shareholders under certain circumstances. LLC members can be held liable for causes, including:

  • A member gives a personal guarantee for a business loan or debt.
  • A member directly and individually damages a person.
  • A member doesn't submit taxes that were held from the employee's wages.
  • A member purposely does an illegal, fraudulent, or reckless act that harms the LLC or another person.

An LLC's Liability for Member's Personal Debts

An LLC's assets usually can't be used by creditors for a member's individual debts. Depending on the state, potential creditor actions include:

  • Charging Order: A court orders the LLC to directly pay a creditor the member's profits in order to satisfy a debt.
  • LLC Interest Foreclosure: A member's interest in the LLC can be foreclosed upon to satisfy a personal debt with a creditor.
  • Order for Dissolution: A creditor can get a court order dissolving the LLC. The member's income from the dissolution and sale of the company's assets is sent to the creditor for the personal debt.

Single-Member LLC Protection

A charging order's purpose is to permit taking a member's income while protecting the LLC's other members. There is no need for the charging order's protection when the LLC is owned by just one member. Some courts in various states have held that single-member LLCs aren't automatically protected by requiring a charging order. Therefore, creditors can foreclose on a member's interest in order to fulfill personal debts.

When Is an LLC Owner Liable for Company Debts?

Members of an LLC may be held personally liable for the debts and acts of the business if the member is proven to have treated the LLC as an extension of their personal affairs instead of as a separate business structure. If a court finds that a member is attempting to hide their personal activities and debts behind the limited liability of the business, then the member may be held personally liable.

How to Maintain the LLC as a Separate Business Entity?

In order for an LLC to be perceived as a separate legal entity, the members should:

  • Act fairly and legally.
  • In no way attempt to misrepresent or distort material facts related to their finances to third parties.
  • Properly fund the LLC.
  • Allocate enough capital to keep the business liquid.
  • Manage LLC finances separately from personal.
  • Operate with a federal employee identification number rather than a personal Social Security number.
  • Conduct business through a separate business bank account.
  • Only track business transactions on the LLC's accounting ledger.
  • Generate an Operating Agreement, which addresses the terms that the company will follow regarding oversight, governing, and long-term operations.

Disadvantages of an LLC

One of the significant inconveniences of an LLC is the lack of flexibility it provides when removing members. Many states will require the LLC to be completely dissolved when a member departs the business. The administrative duties to properly closing the business will also need to be completed. Once the business has been shut down, a new LLC may be created with the remaining members.

Another disadvantage for LLC members is that they're considered self-employed by the Internal Revenue Service. Therefore, they're required to pay self-employment taxes toward their Medicare and Social Security accounts. The tax amount is calculated based on the net income of the LLC.

Steps to Forming an LLC

In order to create an LLC, a Certificate of Formation or an Articles of Organization will need to be filed within the state of creation. In most states, this paperwork will need to be filed with the secretary of state (SOS). Although the filing of the required documents is considered fairly easy, there will most likely be a filing fee charged by the SOS. The Articles of Organization will include such things as:

  • The name and address of the LLC.
  • The name and address of the registered agent.
  • The names and address of the members of the LLC.

An LLC Operating Agreement is considered to be the most significant document of the LLC because it draws out the framework and roles of the business. More specifically, this agreement outlines the working and financial relationships between the managers and members of the company.

Steps to Starting an LLC

The LLC name must be distinguishable from other businesses in the area. It also must indicate that the business is an LLC. The most important step in forming an LLC is to appropriately name it. Taking time up front to make sure a name is well-suited for your business and is easily searchable online will pay dividends in the long run. Business names must end in "Limited Liability Company" or some variant of its abbreviation.

The name of the LLC may not contain misleading words. In fact, each state has a list of words that may not be included in the name of an LLC. For example, the words "university," "bank," "college," or "insurance" are prohibited from being used in most states. The Articles of Organization will need to be filed with the appropriate state governmental agency. This is usually the SOS, but it varies by state and may be the:

  • Division of Corporations
  • Department of Commerce and Consumer Affairs
  • Department of Consumer and Regulatory Affairs
  • Corporate Commission

Once the Articles of Organization have been filed, the LLC's name is registered with the state. An LLC with more than one member should have an operating agreement. An operating agreement is a legal document that specifies the operating procedures and ownership of the LLC. It's not required to complete one in most states, but it's considered best practice to have one.

What Is a Member-Managed LLC?

When LLCs have two or more owners, equal management is shared in the business. This is referred to as a member-managed LLC. Alternatively, it is also an option to designate one person to be responsible for managing the day-to-day operations of the company. This person may be a company member or an outsider. In a manager-managed LLC, only the designated manager may act as a primary agent and make managerial decisions. This allows the nonmanaging company owners to enjoy the profits without the added stress of management.

What Is a Domestic LLC?

A business that operates in the same state in which it was incorporated or organized is called a domestic limited liability or corporation.

What Is a Foreign LLC?

When a company operates in a state other than where it was formulated, it is referred to as a foreign limited liability.

Is There a Specific Designation for a Domestic and Foreign LLC?

In most states, LLC formulation documents do not have a specific designation for a domestic limited liability company, but all have an option for a foreign company.

What Is a Pass-Through Entity?

For tax purposes, the IRS considers an LLC to be a pass-through entity. Basically, this means that income generated from the business is distributed straight to the members who must report the profits and losses on an individual tax return.

How Does an LLC Pay Taxes?

As an entity, an LLC does not file a tax return or pay taxes. Rather, LLC members must complete IRS Form 1065 which specifies each member‘s share of the business to the IRS.

If you need help with forming an LLC or determining your LLC's structure and strategies, you can post your legal need to 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, Stripe, and Twilio.