What is an LLC Business: Everything You Need to Know
“What is an LLC Business?” is a common question for those interested in starting a corporation.7 min read
What Is an LLC Business
“What is an LLC Business?” is a common question for those interested in starting a corporation. LLCs are far less complex business structures than corporations, but they still offer some of the same benefits. It is the simplest business structure that protects individual owners from personal liability for company losses. The structure and management of an LLC are also much more flexible than with the corporate structure.
LLCs also carry the benefit of acting as “pass-through” entities for tax purposes. This means that the profits and losses of an LLC pass directly through to the individual owners, and as a result, the LLC itself does not need to pay taxes on company profits.
Whether the LLC structure is right for your business depends on the short- and long-term goals of your business, the tax implications of choosing an LLC instead of incorporating, and the legal risks that your business will be taking on. Deciding on a business structure is a major decision.
An LLC can be created by filing Articles of Organization with the state government. In most states, this filing goes to the Secretary of State. Each state has its own laws defining and governing LLCs.
Advantages of an LLC
One major advantage of an LLC is that they are not viewed as separate tax entities by the IRS. This means that LLCs do not need to pay taxes. Instead, the members pay taxes on whatever income they derive from the LLC on their own individual income taxes. This contrasts with the traditional corporation, which is required to pay the corporate tax rate.
Although LLCs are not separate tax entities, they are separate legal entities, and as such, just like shareholders of a corporation, members are still insulated from personal liability for company losses.
Any legal entity can be an owner of an LLC; they are easy to form and less costly to maintain than corporations. Unlike corporations, LLCs are not required to have a Board of Directors, to hold annual meetings or keep records, or to make any public financial disclosures.
LLCs are also very flexible in how they can be managed and structured. Members can manage an LLC or they can elect others to manage the LLC for them. The rights and duties of the members can be established in whatever way the members agree to in the LLC operating agreement. And the ownership interest of LLC members can be determined in whatever way the members agree to, regardless of capital or labor contributions to the LLC. Moreover, profits and losses can be allocated to members independently of ownership interests.
All of these points of flexibility sharply differ from corporations, which are restricted in how they must be managed, require a Board of Directors and corporate officers, and generally allocate ownership strictly according to percentage of shares owned.
LLCs are recognized in every state and generally are the preferred entity choice for small businesses for the above reasons.
Disadvantages of an LLC
Unlike corporations, LLCs cannot issue stock publicly. This makes it much more difficult to expand an LLC and to attract new investors. It also makes it more difficult to sell or transfer ownership interest in an LLC as compared to a corporation.
Corporations have been around for centuries, but LLCs have only been an accepted business entity since the 1970s. As such, the law surrounding LLCs is less established. Although all states recognize LLCs, in some areas there is no uniformity of law, which can lead to greater legal uncertainty.
Steps to Forming an LLC
The first steps to forming an LLC are to choose a state in which the business will be headquartered and to choose a name to call the LLC. Many business owners file their LLC in the state that they are located in or where they will be doing business, but others opt to form their LLC in a state with more corporate-friendly laws, such as Delaware.
After choosing a state, it is important to choose a good name. Any name that is already taken is protected by federal trademark laws, so the LLC must have a unique name.
Forming an LLC requires filing Articles of Organization with the state, usually with the Secretary of State. This is a relatively simple document containing the members’ names, the LLC name, and contact information for both, including a Registered Agent for the LLC. Some states may require additional information to be included in the Articles of Organization.
Members should next draft an Operating Agreement. In most states, this document is not legally required, but it is always a good idea to have. An Operating Agreement outlines the rights and duties of each of the members, describes how the LLC will be managed, and plans for contingencies such as what happens when an LLC member wants to leave the LLC.
Business owners should also make sure they apply for any state or local business licenses they need, as well as file a form with the IRS to obtain an Employer Identification Number (EIN).
Should I Form an LLC
Before forming an LLC, business owners should explore other business entity structures, including S corporations, C corporations, partnerships, and sole proprietorships. Corporations are more complicated and costly to create and maintain, but they offer some powerful benefits, as well. Partnerships and sole proprietorships are easy to create and maintain — they don’t even require filings with the state to create — but they don’t offer the benefit of protecting owners from personal liability for company debts and losses.
Because LLCs are not taxed, members only need to pay taxes on the money they get from the LLC on their personal income taxes. This is generally preferential to the way corporations are taxed. Corporations must pay the corporate tax rate on corporate profits, and then shareholders must pay additional taxes on the dividends they receive. This so-called double taxation is avoided with LLCs.
Where Should I Form My LLC
Many business owners choose the state they are from or doing business in to form their LLC. This is often the easiest thing to do. However, it usually isn’t required that business owners form their LLC in the state they are operating or living in, and it often isn’t the best financial choice to do so. Every state has its own corporate and tax laws, and other options should be considered.
For years, Delaware has enjoyed the status as the best state when it comes to corporate laws. Many companies decide to incorporate or form an LLC in Delaware because there is a low corporate tax rate and because laws are very business friendly. Other states offer varying benefits to LLCs. A business attorney can help you understand which states will be best for you based on your business needs and the legal risks your business will be taking on.
When a business will be operating in more than one state, it will need to register as a foreign LLC in the states it is operating in (aside from the state the LLC is formed in).
Types of LLCs
All LLCs offer limited personal liability and pass-through taxation by default. However, LLCs can elect to be taxed as a corporation instead if the members choose so.
A “domestic LLC” is one that is operating in the same state it is formed in. When operating in any other state, the LLC is operating as a “foreign LLC.” A professional LLC forms some specific professional service. Many lawyers and doctors form LLCs. Professional LLCs are often required to operate only domestically because of professional licensing rules. Typically, forming an LLC does not insulate individual members of a professional LLC from professional malpractice claims.
Frequently Asked Questions
- How much does forming an LLC cost?
The cost of forming an LLC varies from state to state. Each state will require initial filing fees and annual fees. Some states, such as California, also impose annual “franchise fees” on LLCs. Expect to spend several hundred dollars initially and every year on fees, plus attorney fees if you opt to hire a lawyer.
- What is a Registered Agent and why do I need one?
A Registered Agent is an individual who is responsible for receiving legal papers on behalf of the LLC. All states require a Registered Agent to be named in the Articles of Organization. Members can also act as Registered Agents.
- Is an LLC a corporation?
No. An LLC is not incorporated and is thus not a type of corporation. LLC stands for Limited Liability Company, not Limited Liability Corporation.
- What is an Operating Agreement?
An Operating Agreement outlines the rights and duties of each of the members, describes how the LLC will be managed, and plans for contingencies such as what happens when an LLC member wants to leave the LLC.
- Do LLCs pay state taxes?
Maybe. LLCs are pass-through entities that do not pay taxes to the IRS. State taxes could still apply, however. Although LLCs are pass-through entities, there are several types of state-level taxes that may still apply to your LLC.
- What about employees of an LLC?
If an LLC has employees, it must obtain an EIN from the IRS and register for Unemployment Insurance and Income Withholding Tax.
Limited Partnership vs LLC
Limited partnerships are entities that have “general partners” and “limited partners.” The general partners have managerial control over the partnership as well as full liability for partnership liabilities. Limited partners are not allowed to participate in managing the partnership, but they are protected from any person's liability for partnership losses or liabilities.
Both general and limited partners share in the profits of the partnership according to the partnership agreement. Limited partnerships can provide tax deductions to employees, and can offer benefits like health insurance. General partners can also deduct pension plan expenses. While an LLC is governed by an Operating Agreement, an LP is governed by a Partnership Agreement that operates similarly.
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