LLC stands for “limited liability company”. It is a legal entity used to form and operate a business. The LLC structure keeps the company separate from its owners.
An LLC is a type of company that protects its owners from personal responsibility for its debts. An LLC provides the same limited liability protection as a corporation but is much easier to form and run.
WHAT IS AN LLC AND HOW DOES IT WORK?
An LLC is a type of business entity that combines some of the characteristics of a corporation with those of a sole proprietorship and partnership.
An LLC offers its owners liability protection from the company’s debts, tax advantages, and a flexible management structure.
They are a very popular form of business structure because they are easy to set up, easy to run, and offer several advantages.
WHO SHOULD SET UP AN LLC?
An LLC is a great business structure for any business owner that wants to limit their personal legal liability. The structure provides the same liability protection as a corporation.
An LLC protects its owners from personal responsibility for the company’s debts and liabilities. They are used to own and run almost any type of business from small private enterprises to large global corporations.
Some states in the US do not allow certain types of licensed professionals to form an LLC. Instead, they must form a type of professional LLC.
These professional LLC companies apply to lawyers, doctors, architects, engineers, and accountants. However, the regulations that control LLCs vary from state to state.
WHY FORM AN LLC?
The main reason people form an LLC is to provide limited liability protection to its owners. This means the personal assets of the company owners are not liable to cover company debts.
There are other benefits to forming an LLC – including pass-through taxation, and flexibility.
PERSONAL ASSET PROTECTION
The greatest benefit of an LLC is its personal asset protection. It creates a legal structure that separates the assets of the company from those of its owners.
This means the owner’s assets are protected and cannot be sought to cover debts incurred by the company.
For taxation purposes, the IRS considers an LLC as a ‘Pass-Through’ entity. This means that LLC companies do not directly pay tax on their profits.
Instead, the profits flow through to the LLC owners and are taxed at the owner’s personal tax rates. LLC owners often qualify for the special pass-through tax deductions that took effect in 2018 called the Tax Cuts and Jobs Act.
LLC companies provide flexibility when it comes to ownership and management structure. There are no limits to the number of owners in an LLC company structure.
LLC companies offer flexibility when it comes to tax by allowing the company to choose how they are to be taxed. The most common tax models used are sole proprietorships or partnership tax regimes.
WHAT IS THE DOWNSIDE TO AN LLC?
There are two downsides to forming an LLC, the costs involved and investment disadvantages. However, these disadvantages are usually outweighed by the benefits of forming an LLC.
COST & FEES
There are costs and fees involved in the formation and running of an LLC. Each state charges an initial formation fee to register your LLC company. And, most states charge recurring annual report and tax fees.
LIMITED INVESTMENT OPPORTUNITIES
LLC companies are not a good option if you plan to seek outside investment down the road. Corporations work best for seeking outside investment because they can sell stock as shares in the company. This is more difficult with an LLC.
For more information on the pros and cons of an LLC see – Advantages & Disadvantages of LLC.
WHAT OTHER TYPES OF COMPANY ARE THERE?
The other types of company you can form in the US are Corporations, Sole Proprietorship, and Partnership.
A corporation is a company that is recognized as a legal entity separate from its owners. It can hold its own property, hold bank accounts, borrow money, sue or be sued, and perform any business action that a human can do.
The main difference between an LLC and a corporation is the ability to offer investors stock ownership. However, corporations must pay tax on their profits in the form of corporation tax. For more see – LLC vs C Corp.
A sole proprietorship is a business with a single owner. It is the easiest and cheapest way to form a one-person business.
You automatically become a sole proprietorship if you start a business and don’t form an LLC, incorporate, or have a partner. Legally, a sole proprietorship is inseparable from its owner.
For more information on the differences between an LLC and a sole proprietorship check out – LLC vs Sole Proprietorship.
A partnership is similar to a sole proprietorship except there is more than one owner. You automatically form a partnership if you form a business with a partner or partners and don’t form an LLC or incorporate
This type of company is a form of shared ownership. In a partnership, the company is legally inseparable from its owners. Partnership companies do not pay tax and instead pass through their profits to the company partners. For more see – LLC vs Partnership.
HOW DO LLC MEMBERS GET PAID?
LLC members, (owners), get paid by taking money from their share of the company’s profits. When an LLC company makes a profit the money is shared out amongst its owners – who are called ‘members’.
There are two types of LLC and members get paid differently depending on the type of LLC formed. When discussing ‘what is an LLC company’ we need to be aware that two types of LLC exist, Single-Member LLC and Multi-Member LLC.
A single-member LLC has one owner. The single owner is treated as a sole proprietor for tax purposes. The owner gets paid by writing themselves a business check for the profit share earned.
A multi-member LLC has more than one owner. Here, members get paid by taking a draw from the LLC capital account.
The capital account records each member’s share and their financial activities with the company. Owners of a multi-member LLC are treated as partners in a general partnership for tax purposes.
HOW DO I START AN LLC?
Forming an LLC is a pretty straightforward process. The main steps involved are – select a state, choose a name for your LLC, choose a registered agent, file your articles of organization, and finally create an operating agreement.
You can use an LLC formation service to help get your company up and running and ensure all legal responsibilities have been taken care of. Check out our review of the Best LLC Formation Companies 2022.
1: SELECT A STATE
LLC regulations vary from state to state. First up you need to select the state you are going to register your company in and meet the legal requirements for your chosen state.
2: CHOOSE A NAME
The name of your LLC must comply with state laws. In general, you must choose a name that is not already in use and include an LLC designator after the name.
3: CHOOSE A REGISTERED AGENT
An LLC company must have a registered agent. This agent agrees to accept the legal papers in the event the LLC is ever sued. For more see – What is a Registered Agent for an LLC?
4: FILE ARTICLES OF ORGANISATION
To create the LLC you will need to file articles of organization with your state’s corporate filing authority. The process varies between states but the filing office is often called the Secretary of State.
5: CREATE AN OPERATING AGREEMENT
Finally, it is good practice to create an operating agreement for your LLC. This agreement will detail how the company will be run. For more information, see our full guide on What Is An LLC Operating Agreement? – click here.
WHAT IS THE PURPOSE OF AN LLC COMPANY?
In summary, what is an LLC company, and what is its purpose? An LLC is a type of company structure used to run a business. The purpose of an LLC is to create a legal entity that separates the business from its owners.
The main benefit of an LLC company is that it separates the assets of its owners from those of the company. This means an owner’s assets cannot be pursued to cover debt incurred by the company.
Another key benefit is related to ‘pass-through’ taxation. This allows all company profits to pass through to the owner before tax is collected. The profits are taxed once as part of the individual’s tax obligation.
An LLC company also offers a simple and flexible management system. They are cheaper and easier to run compared to corporations. There are no complicated rules, board of directors, officers, or shareholders.
- LLC vs S CORP – click here
- PROS AND CONS OF LLC FILING SERVICES – click here
- PROS & CONS OF REGISTERED AGENT SERVICE – click here
ABOUT THE AUTHOR
Editor in Chief
Jason is editor in chief at My LLC Guide. He holds a wealth of business management experience and has been advising companies on business formation issues for many years. Jason specializes in resource planning management, staff utilization, and productivity consulting.
He has worked predominantly in the west coast area where he graduated from the Marshall Business School at the University of South California. When he's not working in his business advisory role, Jason likes to climb on his Indian Scout motorbike and enjoy the open road.