Last updated: September 15, 2022

LLC stands for limited liability company. It means that members of an LLC are limited in their liability by the amount they invest into the company.

In other words, if the company goes bankrupt and owes money to others, only those who invested can be held responsible for paying back what is owed.

This type of structure protects your personal liability and business assets from being used to pay off LLC's debts incurred by your business, which is why it's called limited liability.

What is an LLC?

Two business person shaking hands

An LLC is a type of legal business entity that is used to limit what the owner of a company's personal assets are at risk in case of legal action.

The LLC has what is called "limited liability," so if someone sues the LLC on account for some wrongdoing and wins against it (or an arbitrator ruled in their favor), they typically can only recover what was lost, not what the LLC owner has in their personal bank account.

How Does Limited Liability Company (LLC) Work?

Counting money on the table

The business structure of an LLC resembles how a partnership operates, thus getting a partnership tax treatment. When you form an LLC, it can have more than one owner, and they are called members.

Still, unlike corporations and partnerships where two or more partners must agree on how to run the business, LLCs permit single-member companies with no need for an agreement between members.

Members of limited liability companies (LLC) enjoy protection from creditors and other claimants against their personal assets by declaring what is called a "limited liability."

Limited liability companies are legal entities and can be taxed as a pass-through entity (S corporation, Sole proprietorship, Partnership) or as a C corporation.

The limited liability feature of LLC is the most common form of business operation to offer protection. It's the reason a lot of people form an LLC.

It limits how much an individual member can lose in lawsuits against them personally by separating owners' personal assets from company property.

If anything happens, creditors and other claimants would only be able to go after any profits made or assets owned by the company.

LLCs are relatively easy to set up because of how they are regulated. When you form an LLC, it doesn't require all the state and federal filings required for corporations, so it's possible to set up an LLC in a day or two.

LLC members have rights called "membership interests." These rights allow them to vote on how the company is run and how profits and losses are distributed.

Membership interests can be any of the following:

  • Manager
  • Member with voting rights
  • Operator without voting rights, or salary as a member (manager)
  • An employee without membership interest who works for an LLC and takes orders from one or more members (operators) - often called "knights."

Read More: What is an LLC Managing Partner

The Major Advantages and Disadvantages of an LLC

Business person looking at documents

LLC has several advantages over other business structures (S corporation, C corporation, Sole Proprietorship), but it also has a few drawbacks.

Advantages of LLC

The advantages of LLC include:

Flexibility

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Flexibility is a major advantage because LLCs can be structured in many different ways.

For example, the liability of members is limited to their investment only, and the S corporations own all assets.

This means that if an LLC goes bankrupt or experiences a lawsuit, the owners' personal wealth isn't at risk because they're limited liability protection and a separate entity.

Profit Distribution

One advantage of how LLCs operate is that they can choose how to distribute LLCs ' profits. Members who have voting rights get a share of the company's net business income, which could be in proportion to their membership interests.

Pass-Through Taxation

Rolled dollar bills and coins

LLCs are pass-through taxation entities, meaning they don't pay federal income taxes.

Instead, all profits and losses "pass-through" the business to each business owner in proportion to their ownership share.

This means lower tax liability for LLC owners than with other types of businesses like corporations or sole proprietorship businesses.

Less Paperwork

A person looking through thick files

Unlike other business entities, LLCs don't need to file corporate LLC income tax return forms with the Internal Revenue Service. It applies even when it's considered an S corporation.

This means a business owner saves time and money on filing fees and taxes by using Schedule C as a personal form of taxation instead of Form 700 for business returns.

Unlike other forms of organizations like corporations, LLCs don't need to file corporate LLC personal income tax returns with the IRS.

Unlike domestic LLC, foreign LLC doesn't require filing the Articles of Organization.

Personal Asset Protection 

Another major advantage when you form an LLC is liability protection since liability belongs solely to the company itself rather than its owners, even as S corporations.

A liability lawsuit against the LLC will only affect its assets, not those of any individual owner.

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Disadvanatages of LLC

Putting money on a white envelope

The disadvantages of LLCs include the cost of LLCs and business debts.

Cost of LLCs

The main disadvantage is that starting a company is more expensive than a sole proprietorship since you need an attorney or any other professional advisor to set up your business entity.

Business Debts

The major disadvantages are they're not able to take advantage of some tax benefits sole proprietors have, like deducting personal expenses from taxes. It applies even when filing fees for tax purposes are waived.

Also, LLCs are subject to the "double taxation" rule, which means that both the company and LLC owners pay taxes on profits.

FAQs

Why Would a Person Set Up an LLC?

An LLC is set up to create a business structure that protects the personal assets of the company's owners from being used in case of bankruptcy or other legal action taken by creditors.

 

It's ideal for single entrepreneurs, small businesses, and start-ups to create and conduct business that shields their personal assets from the risks of running a company.

Is LLC Good for Small Businesses?

Smaller businesses have the option of forming a single-member LLC.

In this case, only one member is the owner, and it may be better for smaller business owners who want to keep their finances private or have many different income streams.

Many people are not aware that they can use an S-Corp in addition to this single-member LLC. This helps them avoid paying self-employment taxes since they are considered as a disregarded entity.

Many single-member LLCs are taxed as sole proprietors or partnerships, but it can be beneficial to use both types of legal entities for business and tax purposes.

What Are the Financial Benefits of an LLC?

There are several financial benefits of forming an LLC. One of the tax advantages is that you can deduct losses from your personal tax return, which can lead to more tax savings.

The other tax advantage is that if your company does well and makes a profit, there will be no double taxation so long as the profits remain in the company rather than being distributed among members.

This is a tax advantage for business owners who operate on the side or those with downtime between jobs.

You can also use an LLC to own and manage investments such as stocks, bonds, and real estate holdings in other countries. Foreign LLCs can also be tax-exempt depending on the country.

Who Runs LLCs?

One or more legal entities can run an LLC. There are two common types of LLC members:

- multiple members (multi-member LLC), who each own a percentage share in the company;

- corporations, which may not be legal entities at all but rather other legal entities such as limited partnerships converted into an LLC.

LLCs can also have managers who are responsible for the company's day-to-day operation.

LLCs can have both members and managers, or either one of them.

An LLC that has only a manager is called an "unmanaged" LLC. If it's a legal business entity, then LLC management might be handled by the owner(s) through another legal entity.

Managers in LLCs are usually legal entities, such as corporations or partnerships.

Company members, who have a majority vote in an election without a formal meeting of voting shareholders, appoint managers.

This process is called "majority rule voting."

Alternatively, two or more members might also designate managers with a written agreement between them.

What is an LLC License?

LLC license is a registered agent license required for every LLC registered in the United States.

A registered agent service will provide an address and phone number where they can be reached at all times so that any legal documents or mailings can be delivered to them, directing these pieces of correspondence to your LLC's business dealings.

The registered agents are registered with the secretary of state's office and provide a registered address for your LLC.

The registered agent is usually an individual or company who agrees to accept the legal documents from the state on behalf of your LLC, which are then forwarded to you by mail.

What is an LLC Operating Agreement?

A written LLC Operating Agreement is a document that outlines the internal workings of a professional LLC.

It includes provisions for members, managers, LLC capital structure and management, as well as other matters addressed in detail by state LLC laws. Take note, LLC laws vary by location, so review them to know where your LLC stands.

An LLC's operating agreement is important to remember that this legal agreement should be written with great care because it will govern company structures and how the business operates on a day-to-day basis.

The operating agreement will also determine who is entitled to what in the case of an early dissolution or in the event that a member wishes to withdraw from his or her membership interest and sell it.

If you consider forming your own limited liability company, we recommend engaging professional LLC legal counsel because LLC Operating Agreements are complex documents and professional legal advice is pivotal.

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