LLC Protection: Everything You Need to Know
LLC protection shields you from any personal liability for any business debts. 3 min read updated on February 01, 2023
LLC protection shields you from any personal liability for any business debts. A limited liability company (LLC) is a type of business that separates the business from its owners in the same way a corporation does.
If the business cannot pay the supplier, lender, landlord, or any other creditor, the creditor cannot claim the debt against a member's house or car.
Unlike a corporation, which needs to pay its own taxes, the LLC acts as a "pass-through" entity. Any profits or losses aren't taxed at a corporate level. They are paid out straight to the members as dividends who will file the amount on their personal tax return as if they were a partnership or sole proprietorship.
Something important to note is that an LLC is not a corporation.
Professional bodies are not able to register as an LLC, for example, doctors, and attorneys. They will be registered as professional corporations.
Forming an LLC
To form an LLC, the most important document to file is the articles of organization (also known as certificate of organization or certificate of formation). You file this with the LLC division of the state you're filing in, which is usually found as part of the Secretary of State's office.
The filing fees range from $100 to $800 in most states, and you can even form a one person LLC in every state.
You can find the articles of organization paperwork required on the state website, which asks for a few basics in regard to your LLC, such as your name, address, and the contact information for a person involved with the LLC (usually called a "registered agent") who will receive legal papers on its behalf. In some states, you may need to list the names and addresses of LLC members.
The next step is to create an Operating Agreement for your LLC. You don't need to file this with the state, but it is necessary for operation. The operating agreement puts in writing important information like the rights and responsibilities of members, percentage interests for each member, and the members' share of profits.
As mentioned earlier, LLCs are similar to corporations in that the personal assets of members are protected against any business debts and claims. Therefore, if a business were in debt, the only loss for LLC members would be the money spent investing in the LLC. This is the "LL" part of "LLC."
There can be exceptions to this rule. An LLC owner could be liable if they:
- Injure someone personally.
- Personally guarantee a bank loan or a business debt on which the LLC defaults.
- Don't file their personal taxes.
- Purposefully commit fraudulent or do something illegal, causing harm to the company or someone else.
If the owner wasn't treating the LLC as a separate business, the court has the right to rule that the business doesn't really exist, and, as the members are doing business as individuals, they're personally liable.
The "pass-through" tax benefits are a major reason so many businesses form as an LLC. As the dividends are not always paid out regularly, LLC members pay the IRS an estimated tax payment every quarter.
Although an LLC doesn't pay taxes, Form 1065 must be filed with the IRS by co-owned LLC's every year. This form shows the shares of LLC profits/losses each member receives and allows the IRS to make sure correct reporting is done by LLC members.
Known as member management, this refers to small LLCs where all the owners participate as equals in the management of the business. Alternatively, there is a management structure called manager management. This is when an owner (or someone else) is nominated to actively manage the LLC.
The remaining members (often family members who have invested in the LLC) aren't required for anything; they wait for their profit/losses from their LLC shares.
Using the manager management structure means only the named managers have voting rights for management decisions, essentially acting as agents of the LLC. This structure can make sense sometimes, but when it comes to dealing with the sale of securities, there may be complex state and federal laws to deal with.
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