An LLC is a relatively new business form. It was created to let small business owners have a business recognized as its own entity without the bureaucracy associated with starting a corporation. Like corporate entities, an LLC provides its members with liability protection without double taxation. While an LLC comes with many benefits, there are several caveats.

What Is a Limited Liability Company

A Limited Liability Company (LLC) is a business entity that affords small business owners liability protection without the complexity involved in starting a corporation. While it is not as easy to form as a sole proprietorship or partnership, many small business owners find it is worth the paperwork. The LLC's design includes characteristics of a corporation, a sole proprietorship, and a partnership. An LLC's makeup includes the following:

  • Corporation-like liability protection.
  • Pass-through taxation derived from sole proprietorship and partnership business types.
  • State statutes, like its corporate sibling without the excessive red tape.

LLC owners are known as members. An LLC owned by one person is called a single-member LLC. Likewise, a multi-member LLC has more than one owner. LLCs can choose their management framework. If all members manage the day-to-day operation, then the LLC is member-managed. An LLC is manager-managed if at least one member is a passive member — a member who only invests in the company. Manager-managed LLCs can include other members, or the LLC can hire a non-member to run the business.

Advantages of an LLC

The entire reason the LLC structure was created was to help small business owners, so there are many benefits to forming an LLC:

  • Pass-through taxation. Unlike a corporation, LLCs are not subject to double taxation. Instead, the income and profits flow to its members.
  • Income tax offsets. Members can offset other income up to their investment amount.
  • No residency requirements. You do not have to be a U.S. citizen or permanent resident to own an LLC.
  • Liability and legal protection. Members assets are safe from LLC creditor collection or lawsuit settlements.
  • Enhanced credibility. Suppliers, partners, and lenders usually find LLC companies more credible.
  • Access to business loans. An LLC can build its own credit through loans and lines of credit.

Disadvantages of an LLC

Creating an LLC structure is not without disadvantages. Some of the obstacles include the following:

  • Lack of uniformity. Each state has its own LLC laws.
  • Self-employment tax. LLC earnings are taxed.
  • Added taxes and fees. Some states mandate LLCs to pay a franchise tax.
  • Limited Life. Some state forces an LLC to cease if one of its members leaves or dies.

How to Form an LLC

Forming an LLC is not as simple as starting a sole proprietorship or a partnership, but it is much easier than creating a corporation.

  1. If your state allows it, reserve your name.
  2. File your articles of organization with your secretary of state. Give your business name and address and the name and address for each member and your registered agent. The registered agent will get official mail and any legal documents on behalf of the LLC. This person must be available during regular business hours. Also, make sure to include the filing fee.
  3. If you must publish your intention to form an LLC in the local newspaper, make sure you do so. You will need to send the proof to the state. Your local newspaper can help you with this process.
  4. Determine whether your business will be member-managed or manager managed.
  5. Make sure to get the proper business license and any other certificates needed to open your business.
  6. Apply for your Employer Identification Number (EIN). This is your LLC's unique identifier (like an SSN except for businesses)
  7. Although you do not have to file an operating agreement with the state, still create one. It will outline member interest, profit distribution, and business decision-making processes, and it will handle member exit and entrance to the LLC. If you do not have an operating agreement and there is a lawsuit, you risk the courts making decisions that may not in be in the best interest of your company.

An LLC offers liability protection to its members without some of the corporate drawbacks. Review your local state statutes to see if an LLC is the right structure for your small business.

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