LLC simply stands for limited liability company. This type of legal entity allows small business owners to protect their personal assets and use the business to shield themselves from the company’s potential debts or liabilities.
An LLC is a hybrid that blends the benefits of two business structures, partnerships, and sole proprietorships together. As a result, these businesses can be owned by a single individual or multiples, which each person is known as an LLC member.
Forming an LLC will protect your intellectual property, minimize the tax burden, and segregate your assets.
Whether you’re the sole proprietor or you have a legal partnership with at least one other person, turning your company into an LLC will provide you with protection from all angles.
During the rest of this article, we will go through and elaborate on some of the key benefits of using this legal entity as well as some of the pros and cons of structuring your business as a limited liability company (LLC).
Read further to learn about the pros and cons of forming an LLC, and whether or not it’s right for you.
Who Should Form an LLC?
If you are a small-business owner who wants or needs legal protection then you should consider an LLC formation, whether they have a legal partnership or sole proprietorship with someone who also makes decisions for the company.
Keep reading as we elaborate more on LLCs compared to other business entities.
The benefits of an LLC
LLCs can be used for practically any purpose and can offer more benefits than any other type of business entity. The dual liability protection that is offered is much better than that of a corporation or partnership. There are many benefits from forming an LLC and it is usually the best structure for operating a small business or SME.
Here are a few of the benefits that you can take advantage of when you form an LLC:
An LLC will protect you from injuries that may occur on your property. Liability insurance will cover the cost of medical bills and other expenses caused by the incident. And if the injured party rejects the insurance and instead decides to file a lawsuit, the LLC framework will protect you in court. If an employee or service causes damage to someone’s property, your LLC policy may provide compensation instead of the company having to pay the costs.
A limited liability company can be created easily with few bureaucratic obstacles and can be maintained without much headache. Unlike a C corporation, limited liability companies are not required to hold periodic shareholder meetings, keep extensive records, or assign positions. Some states require annual reports while others only require biennial reports.
A limited liability company provides the owners with certain liberties that a corporation does not qualify for. S and C corporations must operate under a fixed management structure with an annually elected board of directors overseeing company policies and decisions.
There is also an unlimited number of owners an LLC can have, and the end-of-year profit distributions are usually allocated based on merit instead of equally among the shareholders, as is required by a corporation.
An LLC sounds official and adds credibility to your business entity. It is viewed as a more formal business structure compare to sole proprietorship or partnership.
Access To Business Loans
Forming an LLC may help you gain access to potential business loans while also making it easier to establish a line of credit in order to build a credit history.
The LLC is Taxed
LLCs may also benefit and be set up for tax purposes. It allows LLC members to choose among three different ways of paying income tax. One popular option is to be taxed as an S corporation. Technically an S corp is a tax designation, not its own type of business entity.
What are the disadvantages of an LLC?
Even though the owner or owners of an LLC have the option to choose how they are taxed, the actual tax process itself can be intimidating and more complex than a corporation due to hidden fees and a substantial amount of filing fees.
Checks that are addressed to an LLC cannot be cashed, instead, they must be deposited directly into a business account. Banks may also choose to charge higher fees for an LLC than they normally would for a sole proprietor. Because limited liability companies are not required to hold annual board meetings, they could easily succumb to poor management.
Types of LLCs
Every type of LLC offers the same unique features that set them apart from other business entities: limited liability and pass-through taxation.
Below you will find the multiple types of LLCs that work best for particular kinds of small businesses. If you are thinking about starting a limited liability company then it would be prudent for you to begin weighing the various options beforehand to figure out which model might work best for you.
Domestic and Foreign LLCs
A domestic LLC is a business that is formed and operated within the state in which it does business. A business has to register as a foreign LLC if it decides to operate outside of the original state or country. If a business in California decided to expand into Nevada, then it would have to register with Nevada as a foreign LLC.
Member-Managed and Manager-Managed LLCs
In a member-managed LLC, every owner is directly involved in running the business and is a member of the LLC. Each member of the LLC shares equal blame or recognition and is the most common way LLCs operate. A manager-managed LLC is when at least one owner makes all the business decisions while the other members are passive financiers.
Professional LLCs are a type of limited liability company designed to perform certain professional services such as attorneys, physicians, veterinarians, life insurance agents, etc. A professional LLC must comply with the same rules as a regular LLC, but only those who are licensed professionals qualify for this designation. Since the personal liability limitations do not extend to cover professional malpractice claims, it is advised to seek legal counsel before forming a professional LLC.
Series LLCs use the main LLC with multiple other LLCs, known as cells, that are separate from each other for liability purposes. Each cell LLC is run by its own members and is liable only for its own debts and business obligations, making each one independent from the others but still ultimately controlled by the main LLC.
As of this writing, only twenty states and two territories allow the formation of series LLCs, which are:
- District of Columbia
- North Dakota
- Puerto Rico
- South Dakota
Restricted LLCs are used to transfer personal assets within the family that creates it. It uses the legal and tax eligibility of a regular LLC, the social benefits of a nonprofit, as well as the branding and marketing advantages of a social enterprise. A restricted limited liability company is not meant for conducting business and can only distribute assets after it has been in existence for ten years. This option is currently available only in Nevada.
Anonymous LLCs allow the owner to register the company using a third party in order to protect their identity. The only time the business owner’s name has to be mentioned is within the Articles of Incorporation and annual reports. New Mexico is currently the only state that allows for truly anonymous LLCs.
LLC operating agreement and annual reports
Even though LLC owners have many liberties that corporations do not, they are still legally required to follow certain operating agreements and file annual or biennial reports with their Secretary of State. Failing to file can result in your business being dissolved.
In many states, LLC owners must also submit an operating agreement that explains important provisions and standards expected of the company. An operating agreement is important even if not legally required because it ensures that the courts will respect the limited liability of the owners. Operating agreements usually include issues such as how the LLC will be managed, how the profits will be allocated, and buyout provisions.
Tax options – 4 Tax Possibilities for Your LLC
One of the best aspects of owning an LLC is that you have the liberty to choose how you are taxed. This section will give you an overview of the available options so you can end the fiscal year with more money in your pocket.
Single-member LLCs tax the individual as the sole proprietor and falls under the “pass-through taxation” category. In pass-through taxation, the business doesn’t file any tax forms and all the profits go directly to you, the owner, where the profits are reported on your personal tax returns.
Multiple-member LLCs report their business income on a separate tax return for partnerships. Each owner pays self-employment taxes on their share of the profits.
C corporations are used primarily if you and the other members prefer to keep the profits invested in the company instead of distributing the profits at the end of the year. None of you are taxed on whatever profits remain in the business, and the company is responsible for the payroll of any employee. However, if the profits are distributed to all members in the form of dividends, those dividends are first taxed at the standard corporate tax rate, and then taxed again at the qualifying dividend rate (double taxation).
With an S corporation, the company’s profits are not subjected to corporate taxes, but rather you and the members are taxed on your respective shares of the company’s profits. The company is responsible for paying a payroll employment tax, which includes all of the business owners.
Where, and how, should I form an LLC?
In order to officially register an LLC, you must first hire a registered agent as required by most states.
A registered agent is a legal entity that accepts tax and legal documents on behalf of the business, which can be done by a professional service, a colleague, or the LLC owner themselves given they meet the state’s standards.
From there, the future owner would need to file formation documents with the state’s business division, which is usually the Secretary of State, and pay a filing fee in order to make the business official.
The owner then needs to obtain an Employer Identification Number (EIN) by filing Form SS-4 with the Internal Revenue Service, which can be done online. If the state requires the business owner to pay unemployment, disability, and other payroll taxes, they will need to provide tax identification numbers for those accounts.
In short, the process of starting an LLC can be divided into 5 key steps which can vary slightly from state to state:
For more information on how to start an LLC, check out this guide here.
This article has provided you with a general outline of what it takes to form an LLC. Your next step is to discuss these options with lawyers, tax advisors, and trusted friends and family to see which structure is the best way for you to reach your business goals by evaluating the risks, tax implications, and liabilities you will ultimately be responsible for.
The safest way to protect yourself and your business from frivolous lawsuits are to familiarize yourself with the potential risks and rewards that an LLC has to offer.
There is a reason why an LLC is the most common type of business entity in a county where a new lawsuit happens every time you turn around, and it’s because the pros outnumber the cons by a long shot.
Frequently Asked Questions
What is an LLC member?
An LLC member is simply the owner of the business. Another common term is a shareholder. All three are often used interchangeably.
How do I file an amendment for an LLC?
If you need to make a change to your LLC, you can do so with your Secretary of State.
Can you start an LLC by yourself? – Do I need a lawyer to form an LLC?
Yes, you can, and no, you do not. In fact, LLCs are often the perfect structure for sole proprietors because they provide protection for your personal assets without the complexity and rigid regulations of a corporation.
How do LLC owners pay themselves?
Owners of the LLC do not receive a paycheck. Instead, LLC members take “draws” or “distributions,” which do not have any federal or state income taxes withheld. You are responsible for reporting your share of profits on your personal income tax returns.
How do LLC taxes work?
LLCs can be taxed differently depending on whether they are sole proprietorships or have multiple members, and whether or not you elect to be taxed as a corporation. For more information, talk with an accountant.