LLC Explanation: Everything You Need to Know
An LLC explanation can be very useful to new business owners and knowing the terminology and advantages of forming an LLC can help them make the best decision.3 min read
An LLC explanation can be very useful to the new business owner who wants to take the next step up the professional ladder. Knowing the terminology and the advantages of forming an LLC can help the business owner make the best decision.
Basics of Limited Liability Company
As a new business owner, having an explanation of LLCs compared to other business structures can be useful when making a decision. A limited liability company (LLC) is a form of business recognized across the United States. It is a separate legal entity, much like a corporation. LLCs can obtain a tax identification number, open a bank account and do business with its own name.
LLCs are corporate structures that prevent all members from personal liability for any debt and liability of the business. They are a hybrid business structure. They are a combination of the characteristics of corporations and sole proprietorships or partnerships.
LLCs are exempt from the double-taxation that occurs in corporations. They are similar to corporations with the liability protection. Like a partnership, however, LLCs have the option of a flow-through taxation feature.
LLCs offer pass-through taxation, limited liability and personal asset protection.
History of LLCs
The history of LLCs date back to the year 1874 after Pennsylvania enacted law that allowed limited partnerships. Created by Germany in 1892, the "Gesellschaft mit beschrnkter Haftung" (GmbH) was similar to LLCs. It was a model used throughout South America and Europe during the 20th century.
Wyoming passed a law in 1977 that allowed LLCs for all businesses, with exception for insurance and banking. LLCs quickly rose to be very popular in the United States.
Significance of LLCs
LLCs hold some significance in several ways, including:
- They help connect the dots among the other major business structures, corporations and sole proprietorships
- The owners of LLCs may choose the management style and structure of the business jut as a sole proprietor with the personal liability protection of corporations
- Before LLCs, a small business owner would not be big enough to function as a corporation. The cost of filing the forms and corporate taxes meant they had no other option than a sole proprietorship
Advantages of Starting an LLC
There are a number of advantages of starting an LLC, including:
- LLCs are incredibly flexible, particularly how the profit and management of the business is defined. For instance, LLCs allow the founders to put out a smaller amount of money to start the business but still hold all of the management power.
- The other investors in the business will share in the profit of the business, but not always in the same proportion as their investment.
- LLCs are more flexible, but that can sometimes be a disadvantage.
- Owners have to sign a detailed agreement that details how the profits are divided and how the management is to be determined. The responsibilities in the business, the authority to withdraw money and the responsibility to add new cash are also detailed.
- Pass-through taxes are available for LLC members. You do not need to file corporate tax returns.
- LLCs can opt to be treated as a corporation or a sole proprietorship for taxation purposes.
- A business owner can use corporate taxation for an LLC if they want the advantages afforded to them.
- LLCs provide limited liability protections for all business debt and other obligations. If an LLC has to file for bankruptcy, the members are not typically required to pay LLC debt with their personal finances. If the LLC does not have enough money to pay the debt, creditors do not go to the members for payment. The members do not own the debt; it belongs to the LLC.
- LLCs are a business structure that is not connected to the owners.
- LLCs are not required to hold formal meetings or recording meeting minutes.
- LLCs do not issue stocks like corporations.
Limited Liability Protection
LLC members will be protected from any problems stemming from the business, including civil suits, torts or other problems caused by employees or other members in the business. Partners in traditional partnerships have to be responsible for all acts, even those not committed themselves. All employees and members of an LLC that are acting in a form of business are agents of the company, not of single members.
The protection offered by LLCs is known as the limited liability shield, similar to the corporate veil in a corporation. The limited liability shield will not protect members from any liabilities caused by his or her own actions, however.
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