Limited liability company
A limited liability company (LLC) is a hybrid structure that allows owners, partners or shareholders to limit their personal liabilities while enjoying a partnership’s tax and flexibility benefits. Under an LLC, members are shielded from personal liability for the business’s debts if it can’t be proven that they acted in a negligent or wrongful manner that results in injury to another in carrying out the activities of the business.
“Limited liability companies were created to provide business owners with the liability protection that corporations enjoy while allowing earnings and losses to pass through to the owners as income on their personal tax returns,” said Brian Cairns, CEO of ProStrategix Consulting. “LLCs can have one or more members, and profits and losses do not have to be divided equally among members.”
According to TRUiC, the cost of forming an LLC comprises the state filing fee and can range from $40 to $500, depending on your state. For example, if you file an LLC in New York, you must pay a $200 filing fee and a $9 biennial fee, according to LLC University, and file a biennial statement with the New York Department of State.
Although small businesses can be LLCs, some large businesses choose this legal structure. The structure is typical among accounting, tax, and law firms, but other types of companies also file as LLCs.
Understanding a Limited Liability Company (LLC)
Limited liability companies are permitted under state statutes, and the regulations governing them vary from state to state. LLC owners are generally called members.
Many states don’t restrict ownership, meaning anyone can be a member including individuals, corporations, foreigners, foreign entities, and even other LLCs. Some entities, though, cannot form LLCs, including banks and insurance companies.
An LLC is a formal partnership arrangement that requires articles of organization to be filed with the state. An LLC is easier to set up than a corporation and provides more flexibility and protection for its investors.
LLCs may elect not to pay federal taxes directly. Instead, their profits and losses are reported on the personal tax returns of the owners. The LLC may choose a different classification, such as a corporation.2
If fraud is detected or if a company fails to meet its legal and reporting requirements, creditors may be able to go after the members
Forming an LLC
Although the requirements for LLCs vary by state, there are generally some commonalities. The very first thing owners or members must do is to choose a name.
Articles of organization can then be documented and filed with the state. These articles establish the rights, powers, duties, liabilities, and other obligations of each member of the LLC. Other information included on the documents includes the names and addresses of the LLC’s members, the name of the LLC’s registered agent, and the business’ statement of purpose.
The articles of organization are filed, along with a fee paid directly to the state. Paperwork and additional fees must also be submitted at the federal level to obtain an employer identification number (EIN).4
Advantages and Disadvantages of LLCs
The primary reason business owners opt to register their businesses as LLCs is to limit the personal liability of themselves and their partners or investors. Many view an LLC as a blend of a partnership, which is a straightforward business agreement between two or more owners, and a corporation, which has certain liability protections. Although LLCs have some attractive features, they also have several disadvantages. Depending on state law, an LLC may have to be dissolved upon the death or bankruptcy of a member. A corporation can exist in perpetuity. An LLC may not be a suitable option if the founder's ultimate objective is to launch a publicly traded company.
Limited Liability Company vs. Partnership
The primary difference between a partnership and an LLC is that an LLC separates the business assets of the company from the personal assets of the owners, insulating the owners from the LLC’s debts and liabilities.
Both LLCs and partnerships are allowed to pass through their profits, along with the responsibility for paying the taxes on them, to their owners.2 Their losses can be used to offset other income but only up to the amount invested.
If the LLC has organized as a partnership, it must file Form 1065. (If members have elected to be treated as a corporation, Form 1120 is filed.)5
In an LLC, a business continuation agreement can be used to ensure the smooth transfer of interests when one of the owners leaves or dies. Without such an agreement in place, the remaining partners must dissolve the LLC and create a new one.
Frequently asked question's
A limited liability company, commonly referred to as an “LLC”, is a type of business structure commonly used in the United States. LLCs can be seen as a hybrid structure that combines features of both a corporation and a partnership. Like a corporation, LLCs provide their owners with limited liability in the event the business fails. But like a partnership, LLCs “pass-through” their profits so that they are taxed as part of the owners’ personal income.2
The LLC has two main advantages:
- It prevents its owners from being held personally responsible for the debts of the company. If the company goes bankrupt or is sued, the personal assets of its owner-investors cannot be pursued.
- It allows all profits to be passed directly to those owners to be taxed as personal income.2 That avoids “double taxation” of both the company and its individual owners.
LLCs are more common than many realize. There are many much smaller LLCs. There are variations that include sole proprietorship LLCs, family LLCs, and member-managed LLCs.
Many physicians’ groups are registered as LLCs. This helps protect the individual doctors from personal liability for medical malpractice awards.
Yes. In the case of a corporation, profits are first taxed at the corporate level and then taxed a second time once those profits are distributed to the individual shareholders.7 This “double taxation” is decried by many businesses and investors.
Limited liability companies, on the other hand, allow the profits to be passed directly to the investors so that they are taxed only once, as part of the investors’ personal income.
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