Types of LLC: Everything You Need to Know
It is a business formation structure that allows the business members to avail moderate liability as well as more favorable tax treatment under the tax code.7 min read
Updated October 28, 2020:
Types of LLCs vary depending on the industry. An LLC is a business structure that protects the owners and gives the business more favorable tax treatment under the tax code. Since the 19th century, there have generally been three forms of business entities:
- Sole proprietorship
The LLC was invented in 1977. Wyoming created the LLC to address the needs of its business that wanted to be managed and taxed in a manner more closely resembling partnerships while still being afforded the liability protection offered to corporations.
Common LLC Terms
In order to determine whether to form an LLC, you should familiarize yourself with the common terms used to discuss LLCs. For example, "members" are individuals who have an ownership interest in and are responsible for managing the LLC.
Ownership Percentages with LLCs
Similar to the manner in which a corporation issues shares of stock, LLC ownership can be expressed through memberships units or by percentage. More importantly, ownership gives members the right to vote and share in the LLC's profits.
LLCs Compared to Corporations
LLCs are structured similarly to corporations in that the members may form a business without having to worry about being held liable for the business's debts or litigation. In addition, various state laws provide some additional advantages for LLCs over corporations. These particular bonuses mainly revolve around tax treatment.
Understanding Sole Proprietorships
How does a sole proprietorship differ from an LLC? A sole proprietorship is automatically formed when an individual conducts business without the protections offered by a corporation, limited partnership, or LLC. As a result, you could establish a sole proprietorship without even realizing you had done so.
For example, if your children were to sell lemonade on the street outside your home without registering their stand with the state, their business would be considered a sole proprietorship. Similarly, if you were ever to do contract work for an organization and you were not on that organization's payroll, you would be considered a sole proprietor.
Understanding General Partnerships
A partnership is a type of business in which the individuals in the partnership share both the risks and benefits that come with running the business. General partners assume liability for any partnership debts and ultimately for all actions of the partnership. It should be noted that in a general partnership, all partners are general partners. As such, all general partners must participate in the ongoing daily operations and will be responsible for the debts and liabilities of the partnership.
If a sole proprietor brings on a partner, his business is automatically converted to a general partnership. General partnerships are similar to LLCS except in a general partnership, the general partners do not need to make required filings and are not protected from liability.
Understanding Limited Partnerships
Limited partnerships are a cross between an LLC and a general partnership. Since limited partnerships are generally more expensive and complicated to establish than LLCs, most small business owners do not use this structure. In addition, limited partnerships limit the power of the limited partners to make decisions. As a result, limited partnerships are frequently used for estate planning.
Which Business Type in Which State?
The types of business formation structures are established by the legislature in each state. It is within a state's power to allow only specific types of business structures. As such, many states have passed regulations and limitations on the types of businesses that can be established and by whom.
Understanding Professional Corporations (PCs)
Doctors, lawyers, accountants, and architects generally form professional corporations (PCs), a specific type of corporation only available to designated professionals. In certain states, professionals may form a corporation, but each individual remains liable for his or her professional actions.
Limited Liability Partnerships (LLPs)
Limited Liability Partnerships (LLPs) are a business formation structure that includes general partners. However, all general partners in an LLP are able to shield themselves from any liability resulting from another partner or employee's actions. LLPs are very similar to LLCs, but LLPs operate within the confines of the partnership rules.
Multi-Member vs. Single Member LLC
If you want to form an LLC, you must first decide if you will form a single-member or multi-member LLC. Although both options provide you with limited liability protection, there are some differences between each structure to consider.
The biggest difference between these two entities is that a single-member LLC has one owner, whereas two or more people will own a multi-member LLC. Imagine that you own a media consulting firm and have hired several employees, including an account manager. While multiple people work in your business, it would still be a single-member LLC, since you are the only owner. For tax purposes, the IRS considers single-member LLCs to be sole proprietorships.
How Will Your LLC Be Managed?
If you are establishing a multi-member LLC, you will need to draft an operating agreement for your company. In addition to outlining ownership percentages, your operating agreement will describe whether a professional manager will run your company or if your LLC will be member-managed. An LLC that is member-managed is operated by its owners.
When it comes to simplicity, there's almost no better choice than a member-managed LLC. If you choose this management structure, all owners will have the ability to make business decisions and handle important tasks, including:
- Obtaining a loan.
- Signing contracts.
- Dealing with daily operations and finances.
If you form an LLC with one of your friends, and you both decide to participate in the day-to-day operations of your company, your business would be a member-managed LLC.
Foreign and Domestic Limited Liability Companies
When you hear the words foreign or domestic used to describe an LLC, they are describing the location where the LLC was established and operates. Be aware, however, that these terms only apply to the state level, as LLCs are not formed at the federal level.
For example, if you base your LLC in North Carolina, but you do business in South Carolina, your company would be considered a foreign LLC in the latter state.
Forming a foreign LLC is a common choice for companies whose home state does not possess business-friendly laws. Some states offer LLCs more beneficial tax rates and cost-effective formation options, and establishing an LLC in one of these states can be very advantageous. You should understand that just because you sell to customers or work with a client in a different state, it doesn't mean you need to register your company as a foreign LLC. Generally, you need to have a physical business location in that state before foreign limited liability company registration is required.
What Does "Doing Business As" Mean?
If you file a doing business as (DBA), your company can do business using a name other than your legal name. A DBA is also commonly called a fictitious name or an assumed name. In most cases, you will file your DBA in the county where your business is located and operates. Certain states also allow you to file a DBA at the state level.
If you are forming a general partnership or a sole proprietorship, the name of your business will be your legal name unless you file a DBA.
Should You File a DBA?
General partnerships and sole proprietorships can benefit greatly from registering as a DBA. For instance, with a DBA filing, you will not need to follow the same regulations needed to establish a limited liability.
For an LLC, the main benefit of a DBA filing is that it permits the company to do business under a different name. Understand, however, that a DBA registration will not change the legal name of your company. To change your LLC's official name, you would need to amend your Articles of Organization.
How to Form an LLC or Corporation
If you want to establish a limited liability company or a corporation, you need to file the appropriate documents with your state. For a corporation, you would need to complete and submit Articles of Incorporation. LLCs are required to file Articles of Organization.
The benefit of incorporating your business is that it shields you from personal liability. Unlike the owners of partnerships and sole proprietorships, your personal assets will be protected from business obligations if you incorporate.
Types of Corporations
Before you can incorporate your business, it's important to research the different structures from which you can choose. A traditional C corporation, for example, legally separates you, the owner, from your business. Your C corporation will be formed at the state level, and once established, you cannot be held personally liable for the debts of your business.
Limited liability companies are also formed at the state level. An LLC will provide you with the same personal protections as a corporation, but they will be considerably easier and more affordable to incorporate.
LLC Strengths and Weaknesses
There are three business structures that provide company owners with limited liability:
- C corporations
- S corporations
- Limited liability companies
If you own a small business, forming an LLC or an S corporation is typically the best choice. The benefit of forming a C or S corporation is that expanding your business will be much easier. If necessary, you will also be able to bring on new owners without difficulty.
An S corporation is a good choice because these entities are not at risk for double taxation, which is a drawback of a C corporation. After forming an S corporation, you will be able to distribute corporate income to shareholders, who then report this income on their individual return.
You should learn about the strengths and weaknesses of limited liability companies before deciding how to structure your business. For instance, LLCs must handle employment taxes differently than other entities, which may be a concern if your company has a large number of employees.
Choose Your Structure
Before you decide whether to incorporate your business or use a DBA filing, there are several factors that you should consider. The business entity that best meets your needs can depend on a variety of factors, including the nature of your business, your current financial situation, and your future plans.
Consider whether the name you have chosen for your business actually reflects the purpose you have described in your formation documents. You should also think about whether you would benefit more from creating a subsidiary of your current business or establishing a completely new business venture that will operate in tandem with your current business.
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