What Type of Business is an LLC? | All You Need to Know
A limited liability company (LLC) represents a type of business structure that any company can use, whether it's a one-person operation or what the Internal Revenue Service (IRS) calls a "disregarded entity."
With over a decade of practice as a business consultant for limited liability companies, I helped clients across various states regarding forming, organizing, and managing LLCs.
As my specialty, I will comprehensively explain what type of business an LLC is, its structure, types, and the advantages of forming one.
Quick Summary
- An LLC is a business structure covering its owners or members from liabilities.
- The structure of a limited liability company can be a corporation, partnership, or sole proprietorship.
- According to SBA data, over 60% of small businesses select a limited liability structure to safeguard personal assets.
- Most of my clients often opt for a business structure that can help them enjoy an array of tax benefits, like an S corporation.
What Type of Business Is an LLC?
An LLC, popularly known as a limited liability company, is a type of business structure that covers all its members or owners from any liability incurred by the business.
No debts or obligations can be extended to the personal properties of the LLC owners or members unless under exceptional circumstances stated by each state.
Additionally, an LLC isn’t limited to a single member. Anyone can become part and parcel of the company, provided they believe in themselves.
"An LLC, or limited liability company, in the U.S. shields its owners from personal liability for company debts and combines features of both corporations and partnerships or sole proprietorships."
- Jon Morgan, CEO, Co-Founder & Editor-in-Chief of Venture Smarter
LLC Structure
A limited liability company is a business entity that offers much flexibility regarding its structure.
According to the U.S. Small Business Administration, an LLC can be set up so that the owners are personally liable for the debts and obligations of the business, or it can be structured so that the owners have limited personal liability [1]. In fact, data from the SBA indicates that over 60% of small businesses opt for a limited liability structure to protect personal assets.
This flexibility makes the LLC a popular choice for business entities of all sizes.
1. LLC as a Sole Proprietorship
Sole proprietorships are business entities owned and operated by a single owner.
The owners of a sole proprietorship are personally responsible for all debts and liabilities incurred by the business.
There is no separation between the business and the owner, so the owner's assets can pay off debts.
If you set up your business as a single-member LLC, the Internal Revenue Service will instantly regard it as a sole proprietorship. However, you will still have the protection of limited liability.
Sole proprietors report personal income tax on their tax returns.
They have to pay self-employment taxes, equivalent to Social Security and Medicare, on both incomes earned by the business and personal investment income.
2. LLC as a Partnership
If you have an LLC with multiple owners (two or more owners), the Internal Revenue Service will automatically treat your new company as a general partnership.
This is excellent news if you want the liability protection of an LLC and the tax benefits and ease of operation that come with a limited liability partnership.
General partnerships can also file to be treated as a corporation with the IRS if they meet specific requirements.
3. LLC as a Corporation
Single-member and multi-member LLCs can be treated as corporations (a C or S corporation). However, these tax elections come with some strings attached.
A C corporation LLC is taxed like a traditional corporation. If that's the case, the LLC files a tax return and pays corporate taxes (federal and state taxes) at a corporate rate.
Profits are reported on corporation owners' personal income tax returns, but a limited liability company can choose how it wants its profits and losses allocated among members.
An S corp LLC is taxed like a partnership (default), with all the corporate profits or loss passed through to owners.
S Corps are classified as pass-through businesses because business income and losses pass through to the corporation's owners' tax returns.
However, there are also other taxes that pass-through entities are obligated to pay. These include self-employment taxes (Medicare and Social Security) and state and local taxes.
Tax Foundation suggests that pass-throughs with multiple employees and owners are expected to remit a 6.2 percent tax on their profits and set aside 6.2 percent of their employees' wages during each pay period [2].
An S corporation's earnings and deductions are similar to a partnership's.
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What Does an LLC Offer to Its Owners?
Limited liability companies offer business owners several vital protections. For example, their assets are typically protected if they go bankrupt.
This is essential protection for business owners who want to ensure they will not lose their possessions, such as cars or homes.
Additionally, limited liability companies offer tax benefits and can be less expensive than other business structures.
Pass-through taxation LLCs offer one of the safest ways to circumvent double taxation by reporting their income on personal tax returns.
This means that the company's income is not taxed separately - once at the corporate level and once again when distributed to shareholders, which is the case with some corporations.
LLCs are also less expensive to set up than other business structures, such as corporations. This can be a significant advantage for businesses starting and having little money to spend.
FAQs
Is LLC the Best Structure for a Small Business?
An LLC is the best structure for small businesses because it is not expensive to set up or maintain and is easy to manage. It is important to note that different states have varying laws regarding the formation and requirements to establish an LLC.
What Is the Main Difference Between a Professional and a Regular LLC?
The main difference between a professional and a regular LLC is that owners of the former must have licenses, whereas the latter doesn't need them.
What Is the Legal Structure of an LLC?
The legal structure of an LLC is the separation of the company's assets from the personal property of its members. LLCs are popular because they provide limited liability protection to their owners.
References:
- https://www.sba.gov/business-guide/launch-your-business/choose-business-structure#
- https://taxfoundation.org/taxedu/glossary/pass-through-business/
