What is a Limited Liability Company?
A Limited Liability Company, or LLC, is one type of legal entity that can be formed to operate a business. LLCs provide a business owner with liability protection , the option to choose how they are taxed, and maximum control over business decisions and operations.
Limited Liability Companies are distinct, separate entities from the owners. This provides the owner or owners of an LLC with asset protection . If the LLC is ever involved in a lawsuit or credit collections, the owner’s personal assets will not be at risk.
There is a lot of flexibility in the structure of an LLC which allows business owners to make the best decisions for themselves and their companies. LLCs are taxed like a sole proprietorship or partnership by default; however, an owner can file an application with the IRS to be taxed like a corporation.
An LLC is a great option for small businesses just starting out because like a sole proprietorship, it is easier and less expensive to form than a corporation, but it provides protections for the owner just like a corporation.
For information about the definition of a Limited Liability Company, click here.
How Limited Liability Companies Work
When an LLC is formed, it becomes its own legal entity separate from the business owner or owners. An LLC must have a registered agent and must file articles of organization or a certificate of formation with the state in which they are doing business.
Although LLCs are not required to have bylaws like corporations, many companies choose to write an operating agreement for their business.
Forming an LLC is fairly easy. Each state has their own laws regulating the formation of LLCs however, LLCs are almost always required to file articles of organization or a certificate of formation with the Secretary of State in which they plan to do business. This document will require information about the company like:
- The name of the LLC
- The effective date of the formation of the LLC
- The name and address of the registered agent of the LLC
- The company’s principal office
- The business purpose or sometimes called “general character” of the LLC
- Duration of the business
- The name and address of one member of the LLC
- The name and address of each organizer of the LLC
- Some states require a copy of the name registration certificate
- Signature of the authorized representative
Many business owners choose to form a Limited Liability Company because of the tax benefits. An LLC is called a pass-through entity. The company’s profits and losses pass through the business and are filed with the owner’s personal tax return.
Using a Schedule C form, the LLC owner will report their businesses profits, losses, and deductions to the IRS. If there is more than one owner, each owner will file profit and losses with their own personal tax return.
Read this article if you would like to find out more about LLC formation documents.
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How Limited Liability Companies Can Protect You
The protection offered by Limited Liability Company formation is usually the biggest reason why an owner would opt for an LLC over a sole proprietorship. Because an LLC is a separate legal entity from the owner, the owner is not liable for the LLC’s risks and debt. In most cases, an LLC owner only risks what they have invested into the business.
There are however exceptions to this protection:
- An LLC owner will still be personally liable in a lawsuit for their own negligence, even if the claim is related to the business.
- An LLC owner will be liable for any personal guarantees made.
- Liability protection does not cover intentional fraud or illegal activity.
- If the owner fails to keep the LLC as a separate entity, they may lose protection from the LLC.
In addition, an LLC does not protect an owner from losses due to fires, floods, lawsuits, or an economic downtown.
To ensure that you are always protected under your Limited Liability Company, you should take the following actions:
- Have a business insurance policy.
- Maintain your LLC as an independent entity.
- Open business bank accounts and business credit lines.
Pros and Cons of Limited Liability Companies
Forming a Limited Liability Company rather than a sole proprietorship or a corporation has many advantages. It does however also limit a business owner in certain areas as well. Below are the main advantages and disadvantages associated with forming an LLC.
Advantages of an LLC
- Limiting Personal Liability for Business Debts: An LLC protects an owner from certain liabilities, one of these is liability for business debts. An LLC separates the owner from the business so in the event of a lawsuit or claim of a creditor, only business assets are at risk to be claimed to satisfy a business debt. An owner’s personal property and assets like real estate or personal bank accounts are protected. This is generally the most important reason a business owner chooses an LLC over a sole proprietorship.
- Ability to Raise Capital from Investors: The owner of an LLC has the option to bring in investors who can contribute additional capital, property, or even services to the business.
- Tax Advantages: When operating an LLC, the owner will not have to file a separate tax return for the business. LLCs are often called a “pass through entity” because profits and losses from the business pass through the business to the owner’s personal tax return. One benefit of this tax structure is avoiding the “double tax” that most corporations are subject to where income is taxed first under the corporation and then again at the individual level.
- Simplicity and Flexibility: An LLC is one of the easiest legal entities to form. It is less expensive and easier to maintain because it does not require directors and shareholders like a corporation.
An LLC also provides endless flexibility for a business owner. There are no limits on the number of owners allowed so an owner or owners can choose how to run and manage their business. An LLC with more than one owner can also choose how they want to be taxed whether it be like a sole proprietorship or like a corporation. Opting for an LLC to be taxed like a corporation has its own unique business benefits.
Disadvantages of an LLC
The biggest disadvantage of an LLC concerns finances. An LLC will be more expensive to start and run than a sole proprietorship and an LLC lacks investment opportunities that a corporation may have.
If an owner is seeking to bring in outside investors, there are no stock options available in an LLC like there are in a corporation. Normally, an investor will trade funding for a share in the business stock. Without the available stock, there is less incentive for an investor to invest in an LLC.
Limited Liability Company Examples
When most people think about Limited Liability Companies, they think of small businesses. Below is a list of company types that may be set up as LLCs:
- Boutique store selling clothes
- Bagel stores
- Family-run grocery stores
- Gyms and workout facilities
- Coffee shops and cafes
Get Help Forming an LLC
Do you have questions about forming a Limited Liability Company and want to speak to an expert? Post a project today on ContractsCounsel and receive bids from LLC Lawyers who specialize in business formation.
