What is an LLC? Limited Liability Company Explained

LLCBase is your go-to place for everything about LLCs, and it's led by Brian Cohan, who's an expert in the field. Brian and our team are here to give you clear and helpful advice on how to set up and manage an LLC. We've been through the process and know the ins and outs. Our articles and guides are based on real experiences, making them practical for you. We're committed to helping you make smart choices for your business. With LLCBase, you're in good hands as you navigate the world of LLCs.

Are you preparing to piece together the puzzle of starting your own business? Have you heard of a Limited Liability Company (LLC) and want to know more? Well, unlocking the code of business structures doesn’t have to be difficult, and a key player you’ll want to get to know is the LLC. This intriguing structure brings together the limit of your personal liability for your business outcomes and the flexibility and efficiency of operational procedures. 

The LLCBase Editorial Team has dedicated time and expertise to examine the LLC structure with a fine-tooth comb. We’ve carefully defined what an LLC is and made detailed comparisons against other business structures, unmasking all its strengths, possibilities, pros and cons, and why start an LLC for your venture. Curious? Get ready to unravel the mystery of LLCs and unpack the information you’ve been looking for. Let’s dive in!

What is a Limited Liability Company (LLC)

LLCs are chiefly prevalent in the United States, having been introduced as a business model in 1977 in Wyoming. This business design provides its owners with a ‘limited liability’ similar to those held by corporation shareholders, implying that the owners are not personally responsible for the company’s debts and liabilities. This is vital as it ensures that the members’ personal assets (such as houses, cars, and savings) can’t be seized to cover the company’s liabilities. However, the LLC must maintain clear segregation between personal and business finances to protect this limited liability status fully.

In contrast to corporations, an LLC’s profits and losses can pass directly to its owners without being subject to corporate tax rates, thus offering pass-through taxation benefits to its members, similar to a partnership or sole proprietorship. Yet, unlike a corporation, there is no requirement for a board of directors or officers, thus providing a more flexible framework for LLCs.

Governance is usually outlined in an operating agreement, which is like a partnership agreement, setting out the structure of the LLC, including roles, responsibilities, and procedures. The handling of management and decision-making in an LLC is flexible and can be established in a way that best suits the company’s business needs.

If you’re setting up to establish your LLC, one step that you shouldn’t overlook is choosing the best LLC formation service for your needs. So before you choose, don’t forget to check our detailed analysis to find a service that perfectly suits your unique business requirements.

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Top Things You Need to Know About LLCs

An LLC, or Limited Liability Company, is a specific type of business structure that combines elements of partnership and corporate structures. Read some of the top things you should know about an LLC.

1. Liability Protection, Profits, and Losses in an LLC

While the members of an LLC have the advantage of limited personal liability for business debts, they share in the company’s profits and losses. This is by the ownership percentage or another agreement in the LLC’s operating agreement.

For example, if one member has a larger ownership percentage, they may see a larger share of profits and be responsible for a larger part of the losses. The profits of an LLC are subject to tax, but they are taxed directly to the members of the LLC and not at the corporate level.

This avoids the double taxation that corporations are subject to, where profits are first taxed at the corporate level and then again on the individual’s tax returns.

2. LLC Membership and Management 

Operational flexibility is one of the key advantages of an LLC. The LLC’s members determine the management structure and can be managed directly by the members or by hired managers. This means it can be owner-managed or manager-managed, and the members determine this during the formation of the LLC.

There is no limitation or restrictions on the number of members an LLC can have, and members can include individuals, corporations, other LLCs, and foreign LLCs. Therefore, an LLC can have just one member (known as a single-member LLC) or numerous members (referred to as a multi-member LLC). Such flexibility makes the LLC an attractive option for businesses of all types and sizes, from single-owner businesses to larger multinational corporations.

3. The Scope and Benefits of an LLC

The scope of an LLC is wide and versatile due to its flexible management structure and limited liability feature. It is suitable for medium-risk businesses, owners with significant personal assets they want to be protected, and owners who want to pay a lower tax rate than they would with a corporation.

LLCs can also raise money from investors through the sale of membership interest. Moreover, an LLC has fewer administration complications and regulations than a corporation, while it still provides the owners with the desirable limited liability feature.

4. Operating Agreement in an LLC

An important aspect of running an LLC is the operating agreement. It is a legal document that outlines your LLC’s ownership and member duties. This agreement allows you to create rules that govern your business, thus providing an organizational structure and protecting it from potential legal issues.

While not every state requires an operating agreement, it is highly recommended to have one, as it provides a clear set of rules and expectations for your LLC and helps prevent potential conflicts among members.

5. Changes in an LLC 

It should also be noted that an LLC is typically dissolved when a member leaves unless a clause in the agreement allows it to continue. This can be important when deciding whether an LLC is the right business structure for you. A new LLC must typically be formed with a new operating agreement if a member departs or a new one is added. Therefore, the operating agreement must have clear stipulations about these scenarios to prevent confusion or disputes.

Pros
  • Limited Liability: Owners’ personal assets are protected from business debts and liabilities. 
  • Flexible Management Structure: There are fewer formalities and less paperwork than a corporation.
  • Less Reporting: LLCs often have fewer state-imposed annual requirements and ongoing formalities.
  • Profit Distribution: LLCs have flexibility in distributing profits among owners.
  • Tax Advantages: With “pass-through” taxation, business profits and losses are reported on individual tax returns, avoiding double taxation.
Cons
  • Cost: Setting up an LLC can be more expensive than forming a partnership or sole proprietorship.
  • Self-Employment Taxes: LLC profits may be subject to self-employment taxes unless you are taxed like a corporation.
  • Potential state-imposed fees: Some states impose additional taxes on LLCs.
  • Limited Life: In many states, when a member leaves an LLC, the business is dissolved, and the remaining members are responsible for all remaining legal and financial obligations.

Getting Started with Your LLC

Before setting up an LLC, note that while there may not be additional fees for forming your LLC, fees for formation, annual reports, and other mandatory taxes may apply. Below is what an LLC entails. An LLC business structure combines sole proprietorships and partnerships with several advantages. Key aspects of an LLC include:

  • Members’ personal assets are generally protected from business debts in an LLC. However, if the LLC faces lawsuits for business debts, courts may pierce the corporate veil to use owners’ personal assets to cover corporate liabilities.
  • You can choose how your LLC should be managed, for example, by a member or a manager.
  • LLCs benefit from pass-through taxation not subject to corporate income taxes. Instead, members pay taxes on personal incomes based on their individual earnings.
  • LLC costs are much cheaper compared to other business structures. Some places offer tax deductions on LLC filing fees, making it even more affordable.
  • Utilizing a professional LLC formation service can streamline the setup of your LLC.

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These core points cover the basics involved in setting up an LLC. More information can be found in our comprehensive guide about LLCs, as well as a step-by-step guide provided to understand the process better.

Step 1: Choose Where to Register the LLC

The initial step in forming an LLC involves deciding where to register it. The registration should ideally be done where you reside or intend to do business. Each place has its own rules and regulations regarding LLC formation, so you should familiarize yourself with the fees, taxes, and other policies before setting up your company. If you use a pro, you’ll receive all the necessary guidance promptly.

Step 2: Choose a Unique Business Name

The first step in creating an LLC is selecting a memorable and unique business name fitting your brand and complying with the naming regulations of the registration area. Before finalizing your choice, ensure that another business does not keenly use the desired name by doing an LLC name search on the relevant authority’s website.

The business name could also be registered as a trademark or a “Doing Business As” (DBA) name. Registering a trademark gives exclusive rights to use your business name, logo, and tagline. A DBA name lets your LLC operate under a different name apart from its legal name – this could be useful if the LLC plans to offer multiple services under distinct brands.

Step 3: Appoint a Registered Agent

Operating an LLC requires a registered agent as the official point of contact between the business and the government. The agent is responsible for receiving legal documents, notifications, and correspondence on behalf of your LLC. A registered person should have a physical address and be available to receive the documents during regular business hours. In picking a registered agent, you could opt for a reliable friend or a third-party company like LegalZoom that handles legal documents and correspondence for LLCs.

Step 4: Register Your LLC

Registering your LLC involves submitting an Articles of Organization to the relevant authority and officially registering the business. The document provides information about the LLC, after which, if approved, the LLC is officially formed.

Step 5: Draft a Comprehensive Operating Agreement

An operating agreement outlines your business’s governance, structure, and policies. The agreement could cover member details, initial capital contributions, profit allocation among members, the management structure, adding or removing members, meeting and record-keeping guidelines, and buyout provisions. Solidify your dream legally and obtain your operating agreement with a dependable LLC formation service like LegalZoom! Don’t skip the fine print of your grand plan.

Step 6: Secure an EIN

An Employer Identification Number (EIN) is critical for various operational aspects of the LLC, like banking, taxes, and employment. Getting an EIN is free and can be done online, by mail, or by fax through the IRS. The number should be safely stored and kept updated if any changes occur.

When obtaining an EIN for your LLC, hiring a professional LLC service like LegalZoom can significantly simplify the process, ensuring accuracy and compliance with legal requirements.

Step 7: Secure Necessary Licenses and Permits

Ensuring your LLC has the necessary licenses and permits is critical to establishing and sustaining a legally compliant business. The requirements for such permits and licenses largely depend on several factors, including your business type, its exact location, and the prevailing rules and regulations in your local area. This guide will help you navigate through the process of acquiring the necessary permits and licenses:

Identify the necessary licenses and permits your LLC needs to operate. You can determine these by consulting your local government websites. Consult with one of the best business attorneys you can trust when securing licenses and permits for your LLC. The common types of licenses and permits include:

  • Business License: A general business license is compulsory for most businesses, allowing them to operate lawfully within a specific city or county.
  • Professional Licenses: Certain industries, such as healthcare, finance, and construction, may require professionals to obtain specialized operating licenses. 
  • Zoning Permits: If your business operates from a physical location, you may need to secure a zoning permit to guarantee compliance with local zoning ordinances.
  • Health Permits: These are necessary for businesses involving public health, such as food services or healthcare facilities. 
  • Sales Tax Permit: A tax permit is required if your business sells goods; this allows you to collect and remit sales tax.

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Step 8: Open a Bank Account

Creating a bank account specific to your new LLC is vital to guarantee proper financial management and efficient operations. A business banking account offers multiple benefits, including simplified accounting, personal assets protection, and enhanced professional credibility.

LLC vs. Sole Proprietorship

One of the most prominent distinctions between an LLC and a sole proprietorship resides in liability and risk. In a sole proprietorship, there’s no legally separate entity— the owner is the business, and the business is the owner. This implies that the business owner is personally liable for all debts and obligations of the business. If legal action is taken against the business, the owner’s personal assets, such as property and savings, may be at risk.

Conversely, an LLC is a separate legal entity from its owners (known as members), offering owners limited liability protection. This means the personal assets of the LLC’s members are generally protected and not considered a part of the company’s assets or liable for the company’s debts or obligations.

From a taxation perspective, both sole proprietorships and LLCs provide pass-through taxation, meaning that the income from the business is only taxed once. However, an LLC offers more flexibility because it can be taxed as a corporation if that is more beneficial. On the front of credibility, an LLC often has a more professional image, which can help when dealing with clients, vendors, and potential investors. On the other hand, a sole proprietorship might carry a different level of perceived prestige because it only sometimes requires formal registration, and there is no distinction between the owner’s personal and business identities. 

LLC vs. Partnership

One of the fundamental differences between a general partnership and an LLC lies in financial responsibility and liability. In a general partnership, each partner is subject to unlimited personal liability for the business’s debts. This means they share responsibility for the partnership’s obligations and are personally liable. Each partner’s personal assets, such as homes or savings, are at risk if the business cannot meet its financial obligations or if there is a legal lawsuit against the partnership.

On the other hand, an LLC provides its members with limited liability protection. Regardless of the amount contributed to the business, the members’ personal assets remain generally secure and separate from the LLC’s liabilities and debts. This level of financial security makes an LLC structure a favorable option for risk-averse entrepreneurs or organizations.

Both general partnerships and LLCs share profits (and losses) among the owners. However, an LLC offers added flexibility as it allows profits and losses to be distributed to the ownership interest in different proportions. This means the members can determine different allocations based on agreements that don’t necessarily have to reflect equal divisions or ownership percentages. This profit-sharing flexibility is an advantage of an LLC over a traditional general partnership.

LLC vs. Corporation

In terms of management, LLCs and corporations follow different structures. Corporations generally operate under stricter guidelines with a board of directors who the shareholders elect to oversee the company’s overall direction. The board appoints officers to manage the day-to-day operations. Mandatory annual meetings and recorded minutes are also typically a requirement for corporations.

On the other hand, an LLC enjoys a more flexible management structure. The members or owners of an LLC can decide whether they manage the business themselves or appoint managers to do so. There’s no obligation to hold formal annual meetings or to maintain and submit meeting minutes.

From a taxation standpoint, the structures of LLCs and corporations also differ significantly. Corporations fall under what’s called “double taxation”. Initially, corporations pay taxes at the corporate level on any profit generated. Then, if the after-tax profits are distributed to shareholders as dividends, these individuals must report the dividends as personal income and be taxed accordingly. In contrast, an LLC is a pass-through entity unless it decides to be taxed as a corporation. It doesn’t pay any corporate income tax on its profits. Instead, the profits and losses of the business are reported on the personal income tax returns of the owners, thereby avoiding the double taxation scenario corporations are subject to.

FAQs

What is a Limited Liability Company (LLC)?

A Limited Liability Company (LLC) is a distinct type of business structure that offers the benefits of both a corporation and a partnership. It provides its owners with limited liability regarding company debts and obligations.

What protection does an LLC offer?

An LLC offers liability protection to its members, which means the owners are not personally liable for the company’s debts and liabilities. This protection is similar to that offered by corporations.

How are profits and losses handled in an LLC?

In an LLC, profits and losses can be passed directly to the owners without taxation of the business itself. This is referred to as “pass-through taxation,” and it prevents double taxation of earnings, unlike what occurs with corporations.

Who are the members of an LLC?

The members of an LLC are its owners. An LLC may have one member (known as a single-member LLC) or multiple members.

How is an LLC managed?

Its members can manage an LLC, or it can appoint managers. Members-managed LLCs are more common and allow all owners to be involved in business decisions and operations.

What is the scope of an LLC?

The scope of an LLC depends on its operating agreement. It can be involved in any lawful business activity, subject to any restrictions stated in its operating agreement.

What are the benefits of an LLC?

The main benefits of an LLC include limited liability protection for its members, flexibility in management and operations, and favorable tax benefits such as pass-through taxation.

What is an operating agreement in an LLC?

An operating agreement in an LLC is a document that outlines the business’s financial and functional decisions. This includes rules, regulations, and provisions related to the business.

Can an LLC change?

Yes, an LLC can change. These could include changes in membership, management structure, or even the nature of the business itself. All changes must be outlined in the LLC’s operating agreement.

How do you start an LLC?

Starting an LLC involves several steps: choosing a business name that complies with your state’s LLC rules, filing the Articles of Organization with the state, creating an Operating Agreement, obtaining an Employer Identification Number (EIN) from the IRS, and fulfilling other tax and regulatory requirements specific to your business and state.

How does an LLC compare to a sole proprietorship?

Unlike an LLC, in a sole proprietorship, there is no legal separation between the owner and the business, which means the owner is personally liable for all the business’s debts. Also, an LLC offers more flexibility and credibility than a sole proprietorship.

How does an LLC compare to a partnership?

Both an LLC and a partnership involve more than one owner. However, an LLC offers limited liability protection, while in general partnerships, partners are personally liable for the partnership’s debts.

How does an LLC compare to a corporation?

While an LLC and a corporation offer limited liability protection, they differ in taxation and management. A corporation is taxed at the corporate level, while an LLC enjoys pass-through taxation. Also, corporations have a set hierarchical management structure and are subject to stricter regulations, whereas an LLC offers management flexibility.

In which situations is setting up an LLC beneficial?

Setting up an LLC is beneficial when there is a risk of legal action against the business, the business has substantial personal assets that need protection, or the business is profitable. The owners want to avoid double taxation.

Does an LLC have to hold meetings or keep minutes?

Unlike corporations, LLCs are not legally required to hold annual meetings or keep minutes. However, having these in case of a legal dispute or audit is a good practice.

Can an LLC have employees?

Yes, an LLC can hire employees. However, members of an LLC can also choose to work for the company directly as self-employed individuals.

Can an LLC be publicly traded?

Typically, LLCs are privately held companies. In case they want to go public, they usually need to convert to a corporation, which is a different business structure that allows for shares to be publicly traded.

When does an LLC end?

An LLC can end when its members decide to dissolve it, when it fails to comply with state requirements, or when it goes bankrupt.

Can foreigners own an LLC?

Yes, most states in the U.S. allow non-residents and foreigners to own an LLC. However, they may still need an ITIN or EIN for tax purposes.

Can an LLC own property?

Yes, an LLC can own real estate or other property. This adds a layer of protection because the property is owned by the company, not the members personally.

Conclusion

LLCs play a significant role in business formation due to their unique legal structure. They provide the owners with limited liability, which separates their personal assets and debts from the company’s. Should a company go bankrupt, creditors can only claim the business assets, not those personally owned by the owners.

Other attractive features of LLCs include simple taxation and an easy establishment process. The company’s profits and losses are reported on individual tax returns, offering an advantage over corporations facing double taxation. Coupled with a straightforward setup process, these benefits have made LLCs the most popular business structure in the United States. Visit LLCBase for more information when starting an LLC.

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