LLC Explained: Structure, Benefits, and Key Rules
Learn how an LLC works, its benefits, drawbacks, tax options, & formation steps. Understand liability protection, management flexibility, and compliance rules. 6 min read updated on August 12, 2025
Key Takeaways
- An LLC combines liability protection of a corporation with pass-through taxation benefits of a partnership or sole proprietorship.
- LLC members generally aren’t personally liable for business debts or lawsuits, but protection can be lost if legal formalities are ignored.
- LLCs offer flexibility in management structure, membership, and profit distribution without proportional investment requirements.
- Ownership transfers can be restricted, and some states may dissolve an LLC upon a member’s death or bankruptcy unless otherwise specified.
- LLCs can choose how they are taxed—default pass-through status or electing corporate taxation.
- Formation steps typically include naming the LLC, filing Articles of Organization, appointing a registered agent, creating an Operating Agreement, and meeting ongoing compliance requirements.
- Advantages include limited liability, tax flexibility, and fewer compliance obligations; disadvantages can include self-employment taxes and ownership transfer restrictions.
Basics of an LLC
If having an LLC explained is something you desire, then you are probably considering running your business as a limited liability company. A limited liability company is a business form recognized in all 50 states that, like a corporation, is treated as a separate legal entity for running your business.
Separate treatment means that an LLC can have its own tax identification number and bank account and do business in its own name. It also means that the owners enjoy limited liability, meaning that their personal assets will be protected from seizure in the event that business debts or legal rulings require compensation—only business-related assets will be at risk.
Because of this, LLCs are often considered hybrid entities, as they combine an essential element of a corporation—limited liability—with an essential element of sole proprietorships or partnerships—pass-through taxation. Having pass-through taxation means that your business profits will be passed through to your personal income tax and not be taxed at the business level, which can be a major benefit for many entrepreneurs.
Thus, there are many ways an LLC can benefit you, especially if you are just starting out in the realm of business. That said, all elements of the LLC should be examined more deeply before one decides to choose it as their business structure.
How an LLC Works
An LLC operates as a separate legal entity from its owners, known as members. It can enter contracts, own assets, borrow money, and be sued in its own name. Most LLCs are formed by filing Articles of Organization with the state where the business will operate, though some businesses also register in multiple states for expanded operations.
LLCs can have a single member (single-member LLC) or multiple members (multi-member LLC), and the members can be individuals, corporations, or even other LLCs. The internal governance is typically outlined in an Operating Agreement, which specifies management structure, voting rights, profit distribution, and procedures for adding or removing members. This document is essential for avoiding disputes and ensuring smooth operations.
Limited Liability Protection and LLCs
Limited liability protection offers LLCs the same kind of legal protection that corporations enjoy. With limited liability protection, LLC members will be protected from civil wrongs, or torts, committed by employees or other members of the company. Such protection comes from the fact that with limited liability protection, representatives of the company are considered to be acting on behalf of the company rather than on behalf of the members of the company. This stands in stark contrast to the situation with traditional partnerships, where the partners can be held liable for both the acts of other partners and the acts of employees.
Taxation and LLCs
LLCs enjoy two distinct advantages where taxation is concerned: pass-through taxation and flexibility. Pass-through taxation means you will only be taxed once for your business profits, thereby avoiding the double-taxation that corporations must deal with. Flexibility means that multi-member LLCs can elect to be taxed as partnerships or corporations and that single-member LLCs can elect to be taxed as a corporation or a disregarded entity, which is essentially a sole proprietorship.
That said, although LLCs can avoid double-taxation, they must still pay the same taxes as all other business types, including sales taxes, property taxes, and business taxes.
LLC Tax Considerations
While most LLCs benefit from pass-through taxation, members must still account for self-employment taxes on their share of business income. This includes Social Security and Medicare contributions, which can be significant for high earners. However, certain elections—such as electing S corporation status—can reduce self-employment tax liability if the owners pay themselves a reasonable salary and take the remainder as distributions.
LLCs must also comply with state-specific tax rules. Some states impose annual franchise taxes or fees regardless of income, and others have gross receipts taxes that apply when revenue exceeds certain thresholds. It’s important to consult a tax professional to choose the most advantageous tax structure and remain compliant with both state and federal obligations.
Membership Flexibility and LLCs
Along with flexibility of taxation, LLCs also enjoy flexibility of membership. This means that in most states, partnerships, corporations, and other LLCs can become owners of an LLC, and there are also no residency restrictions. On the other hand, corporations must adhere to more ownership restrictions. IRS regulations currently in place prevent corporations from having members that are:
- Corporations
- Partnerships
- Limited liability companies
- Non-resident aliens
Membership flexibility also pertains to how profits and managerial authority are delegated. For instance, in an LLC, the founders may only put up a small percentage of the initial investment but still retain all the management authority. Similarly, profit-sharing in an LLC need not be proportional to the member’s investment. Thus, LLCs have much more flexibility in this regard than corporations, although such flexibility may lead to future disputes, so the details of profit distribution and authority should be spelled out in the Operating Agreement.
Ownership Transferability and LLCs
Unfortunately, LLCs do not benefit in all aspects of their operation, and one area with downsides is that of ownership transference. In LLCs, the operating agreement may bar the sale or other transference of ownership, and if such transference is allowed, it may only pertain to the economic benefits of ownership and not the voting rights or managerial powers. Additionally, some states may dissolve an LLC if a member declares bankruptcy or dies, and they may hold single-member LLCs to even stricter transfer restrictions.
Advantages and Disadvantages of an LLC
Advantages:
- Limited Liability: Members are generally not personally responsible for business debts or legal judgments.
- Tax Flexibility: Choose between default pass-through taxation or elect corporate taxation.
- Management Flexibility: Can be managed by members or appointed managers.
- Fewer Compliance Requirements: Compared to corporations, LLCs have fewer recordkeeping and reporting obligations.
Disadvantages:
- Self-Employment Taxes: Unless taxed as a corporation, members pay self-employment taxes on all profits.
- Limited Growth Potential: LLCs can’t issue stock, which can make raising capital more challenging.
- Ownership Transfer Restrictions: Membership changes may require approval from other members and can trigger dissolution in some states.
- State-Specific Fees and Rules: Annual fees, publication requirements, and other compliance rules vary widely.
Frequently Asked Questions
-
What is the main benefit of an LLC?
The primary benefit is limited liability, protecting members’ personal assets from business debts and lawsuits. -
Can a single person form an LLC?
Yes, a single-member LLC is allowed in all states and offers the same liability protection as multi-member LLCs. -
How is an LLC taxed by default?
By default, single-member LLCs are taxed like sole proprietorships, and multi-member LLCs are taxed like partnerships, both using pass-through taxation. -
Do LLCs pay more taxes than corporations?
Not necessarily—tax liability depends on income, deductions, and whether the LLC elects corporate taxation. -
How hard is it to transfer ownership in an LLC?
Ownership transfer can be complex and often requires other members’ approval, depending on the Operating Agreement and state law.
These are just a few of the details to consider when deciding to go with the LLC structure for your business. If you need further help having the LLC explained, 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.