What does LLC mean in business? When used in business, the term LLC means the owner has limited financial and legal liability for that business entity. LLC is an acronym for limited liability company and is a business designation that affords its owners protection from the financial obligations and legal ramifications that come with running a business.

An easy way to think of LLC is like a hybrid form of corporations and sole proprietorships or partnerships. An LLC provides its owners personal protection just like a corporation and it also has incredible tax flexibility that are given to sole proprietors or partnerships. This overlap of functions from other business entities helps LLC owners acquire many of the benefits without the risks.

The Limited Liability Company is one of the most popular businesses in America because it is easy to form and run, it provides flexible management options, owners have limited liability, and the tax benefits are favorable.

How Do LLCs Compare to Corporations?

Limited Liability Companies are similar to S corporations and C corporations because they provide owners the same protection and separation from business liabilities. One of the main differences between corporations and LLCs is the ease to attract investors. Because corporations have limited ownership, they can easily distribute ownerships rights in the form of shares. Limited Liability Companies do not have this same option, which can make acquiring funding as an LLC more difficult.

Benefits to Forming an LLC

There are several reasons to consider forming an LLC instead of other business entities. For one, the LLC designation gives its owners protection that can mitigate personal financial or legal damages that impact the firm. If the company goes bankrupt, the owners are not personally responsible for the debt or liabilities of that company.

Another benefit to forming an LLC is the tax-related advantages. Owners are able to recognize the company's gains and losses on their personal tax returns instead of being taxed at the corporate-level. This pass-through tax method helps business owners avoid hefty taxes because losses can be deducted on personal income and the individual also doesn't pay double taxes.

Not only can you recognize the LLC taxes on your personal return, but you can also pick the tax option that you want your LLC to be represented under. You can decide to tax your LLC like a sole proprietor, a partnership, or a corporation. This tax flexibility lets you customize your LLC taxation to benefit your company the most.

Limited Liability Companies also offer favorable management and ownership options and requirements. Unlike other business entities, LLCs can have owners that are foreign citizens. Limited Liability Companies are also able to have one owner or multiple owners, depending on what its members want. One of the best aspects of LLCs to its managers is the lack of formalities. LLCs do not need to conduct board member meetings and its managers can be active in the day-to-day or silent partners.

Disadvantages to Forming an LLC

Limited Liability Companies are not perfect for every situation. Because LLCs are relatively young, many investors are hesitant to invest in businesses with this designation. Additionally, the lax legal requirements to form an LLC make it easy to form, but hard to conduct strategic agreements with. If you need to strike contracts or partnerships with your LLC, you will likely need to hire an attorney which can create added costs.

Additionally, because an LLC and its members are separate in the eyes of the law, so too must the financials. Even if you're an independent owner of your LLC, you need to keep your business financials separate from your personal records. This organization of documents and recordkeeping can make LLCs difficult.

LLC Management Options

Corporations are well-known for their top-down management structure. In a large corporation, management responsibilities generally fall to a Chief Executive Officer (CEO). The CEO will manage daily business operations but will need the approval of a Board of Directors for major decisions. Management of an LLC is considerably different. Limited liability companies do not have a Board of Directors, and in many cases, the owners of the LLC will be directly responsible for management of the company.

An LLC that is managed by its owners is known as a member-managed LLC. In addition to this management option, you could choose to have your LLC manager-managed. Typically, in a manager-managed LLC, one member will be appointed to manage the company. This member will make all important business decision and oversee day-to-day operations. The remaining members will not have any management responsibilities and will only share in the company's income.

The benefit of a manager-managed LLC is it provides a tremendous amount of flexibility. For example, while you can appoint a single manager to run the company, you could also hire a professional manager. This means none of your company's members would be involved with normal operations.

The IRS and LLCs

How the IRS treats your limited liability company depends on how you formed your business. For instance, if multiple people were involved in the formation of your LLC, the IRS will treat your company as a partnership. If you wish, you can have your LLC taxed as a corporation instead of a partnership by filing Form 8832. When an LLC is formed with only one person, the IRS considers the company and its owner as legally separate entities.

LLCs vs. Other Business Entities

If you want to structure your business so you will be afforded limited liability protections, there are three different options you can choose from:

  • Limited Liability Company
  • S corporation
  • C corporation

Just because forming an LLC provides you with the same liability protections of a corporation doesn't mean incorporating as a limited liability company is the right option for your business. For example, LLCs can sometimes have problems securing funding from investors. The reason for this is some investors consider limited liability companies to be less stable than corporations. Although you may be able to get investors interested in your LLC, you will likely need to work very hard to prove your company's credibility and worth.

The Purpose of LLCs

Many people are unaware that LLCs are actually a very new type of business entities. Before the 1970s, LLCs did not exist, and business only had the option of establishing a corporation or forming a partnership. Unfortunately, both of these business structures have distinct drawbacks.

With a partnership, for example, there is no legal separation between the business and its owners. This means partners can be held personally responsible for the debts of the partnership. The benefit of a partnership, however, is business profits are taxed once. Forming a corporation does protect the owners from personal liability, which is the main advantage of this structure. The drawback is that corporate profits are subject to double taxation, as both capital gains and net profits can be taxed.

The LLC structure was created to provide business with the best of both worlds. When you form an LLC, the owners of your business will receive limited liability protections, like a corporation, and you will be able to avoid double taxation, like a partnership.

LLC Misconceptions

Because many people are unfamiliar with the LLC form, there are some common misconceptions related to this business structure, especially in terms of taxes. The biggest LLC misconception is that these companies are recognized at the federal level. In fact, the opposite is true. LLCs are formed under state law and do not have any federal recognition.

The IRS does not maintain a tax classification solely for LLCs. If you form a limited liability company, you will need to file your taxes as another type of business entity:

  • Corporation
  • Sole proprietorship
  • Partnership

LLCs are treated as corporations by default when it comes to federal taxes, although you do have the option of electing a different status

LLC History

Wyoming was the first state in the country to offer the limited liability structure. Businesses could incorporate as an LLCs in this state starting in 1977. The Uniform Law Commission, an organization that approves and recommends laws, accepted the Uniform Liability Company Act (ULCA) in 1996. Unfortunately, the majority of states decided not to institute the ULCA, and the act has undergone a variety of changes since it was first adopted.

Because these uniform rules for LLCs were never adopted, the rules for forming a limited liability company differ from state to state. According to the IRS, almost anyone can be a member of a limited liability company, with a few exceptions. For example, while most business entities can be LLC members, insurance companies and banks are usually not allowed to own LLCs. LLCs, unlike corporations, are not considered separate from their owners in terms of taxes.

While members of an LLC are shielded from the company's liabilities, these protections do not extend to negligent acts. If a company employee, or one of the LLC members, acts negligently and causes harm to another person, the owners of the company may be held personally liable.

Can You Convert a Business to an LLC?

In many states, a business can be easily converted into an LLC by filing a document called a Certificate of Conversion. In the event that you wish to convert to a Limited Liability Company, you will need to transfer all important information from your previous business into your new LLC's name such as the tax identification number, tax permits, and other business licenses.

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