What is an LLC (Limited Liability Company) and How Does it Work?

Posted on
Young white male researching "what is an LLC" with his laptop and a cup of coffee.

What is an LLC? An LLC is a limited liability company. How do LLCs work? LLCs limit the liability of the owners/shareholders from the debts of the business and against lawsuits against the business.

Congratulations on becoming a new business owner. The next step is to consider setting up your business as a limited liability company (LLC). Doing this offers legal protections similar to a corporation, but allows you to manage your company like a small business. 

In fact, forming an LLC is one of the most important actions for a business to take. To help, here’s some information on LLCs.

Estimated reading time: 11 minutes

What is an LLC?

Like we discussed earlier, an LLC is a limited liability company and they limit the liability of the owners/shareholders from the debts of the business and against lawsuits against the business. 

By blending the aspects of corporations, partnerships and sole proprietorships into a simple and flexible business entity, LLCs shield owners and operators from personal liability (similar to a corporation) and have the “pass-through” tax benefits of a partnership.

Additionally, LLCs offer the same personal liability protection as corporations, but do not require the typical formalities that are required when managing a corporation.

Why create an LLC? 

The main reason to form an LLC is to limit personal liability because LLCs have their own existence. Think of them as artificial persons. The LLC owns the business, not the people forming it.  Additionally, your LLC can enter into its own contracts and deals, can sue someone and be sued, and are liable for their own debts and obligations. 

Forming an LLC is the common sense move for entrepreneurs– especially when you consider the country we live in. Judges award billions of dollars every year in business related lawsuits.

In addition to liability and asset protection, tax advantages and more, incorporating offers tremendous estate planning advantages because it continues to exist even after the death of a shareholder.

What are the major advantages of forming an LLC?

Limited Liability Protection

In our litigious society, incorporating to protect yourself just makes sense. No other type of buisness structure gives you and your business the liability protection offered by incorporation. When you incorporate, your personal assets are not at risk for the debts and liability of your business.

The only thing members and owners are responsible for is the amount of money they personally invest in the business. Personal assets typically are not at risk for the debts and liability of the business.

For example, if an LLC is forced into bankruptcy, the owners will not be required to pay the LLC’s debts with their own personal money. If the assets of the LLC are not enough to cover the debts and liabilities, the creditors generally cannot look to the owners or members for relief.

Asset Protection

It doesn’t take a catastrophic lawsuit to wipe out everything you own. Could you satisfy all your business obligations without tapping into personal reserves or losing personal assets? Incorporating takes this burden off your shoulders knowing that your personal assets cannot be targeted in the event of a business lawsuit.

Many small business owners create an LLC business structure to separate their business assets from their personal assets. By having an LLC, any lawsuits directed towards the company will not affect the business owner’s personal assets. 

If a company is simply running as a sole proprietor or a general partnership, the business owners open themselves up to having all of their personal assets taken in a lawsuit. Existing and unrealized personal assets are all at risk in the event of an unfavorable judgment. By not separating your personal and business assets, a catastrophic lawsuit could wipe out everything you and the business owns. By forming an LLC, you can take the burden off your shoulders knowing that your personal assets cannot be targeted in the event of a business lawsuit.

Tax Savings

There are a ton of tax benefits that come with incorporation. This is because an LLC can be a pass-through tax entity without the restrictions that are imposed on corporations.

LLCs are great for helping your business save on taxes. Typically, an LLC does not pay taxes at the business level. Income and loss are reported on the owners’ personal tax returns, and any tax due is paid at the individual level. By default, an LLC is taxed as a pass-through entity, where the owners just pay taxes on the profits of the LLC at their individual tax rates, not corporate tax rates, and on their individual tax returns that are then submitted to the internal revenue service. 

Many startups and small businesses often create an LLC because they help avoid double taxation. Double taxation usually occurs when an entrepreneur chooses a C-Corp business structure, so the company and the owner are both taxed separately. Forming a limited liability company prevents this because it is taxed more like a sole proprietorship.

Credibility 

By forming a limited liability company you will give your business instant credibility. Once the LLC is formed, you’ll be able to add “LLC” to the end of your company name. Consumers may not know the difference between sole proprietorships and limited liability companies, but once they see an LLC after a company name, they know that the business is credible and professional. 

The LLC will also bring credibility to your business by protecting your business name from competitors. In most states, other businesses may not form an entity or use a trade name that is the same as your corporate name. This will help you as you begin to build the brand for your business.   

Forming a limited liability company might not be the first thing on your mind as you start your business. However, by doing your research ahead of time and forming your business entity, you can avoid potential problems in the future. As you form the LLC and have questions, be sure to seek legal advice so that you start your business on the right foot.

Ease of Operation

They do not require a board of directors, meetings, quorums, minute keeping, and other management formalities.

Flexible Finances

A limited liability company can distribute its income to each member equally, based on his or her capital contributions, or in many other ways. 

How do you form an LLC?

The owners, called “members,” file Articles of Organization and set out an Operating Agreement. An LLC is a pass-through type of business because the profits and losses are passed on to the members, depending on their share of membership.

While it is easy and inexpensive to form an limited liability company, the steps of how to do so tend to vary from state to state. As a result, you should check with your specific state to find out what you need to do. Typically, the steps include:

  • Choose a business name that is different from existing LLCs in your state
  • File paperwork (Articles of Organization) 
  • Pay a filing fee (from $100 to $800)
  • Create an LLC operating agreement (outlines the responsibilities of each member)
  • Appoint a Registered Agent (the person representing the LLC and designated to receive any legal documents relating to a lawsuit)
  • Publish a notice of intent to create an LLC (only required in some states)
  • Obtain required licenses and permits

In conclusion

The truth of the matter is, every entrepreneur needs to incorporate their business. Not just because it adds credibility, makes it easy to get funding and comes with a ton a tax perks…but because it allows you to operate with peace of mind knowing you and your assets are protected.

While this information can be a great starting point, Inc Authority can answer any additional questions you have. And when you’re ready to form your business, we will set it up for free. Give us a call today at 866-545-1867 to speak with one of our business experts.

FAQ’s

What is an LLC?

A limited liability company (LLC) is a fairly simple business structure. The main reason to form an LLC is to limit personal liability because LLCs have their own existence. The LLC owns the business—not the people forming it. LLCs enter into their own contracts and deals, can sue and be sued, and are liable for their own debts and obligations.

Who owns the LLC?

Individuals called “members” own an limited liability company. These owners have an equity interest in the assets of the business, shown in the business balance sheet as owners’ equity. An LLC with one owner is known as a single-member LLC and an LLC with more than one owner is a multi-member LLC.

How are the profits and losses of an LLC managed?

The profits and losses of a limited liability company are passed through to individuals and filed on their personal income tax returns.

Can I form an LLC entirely online?

Yes! To do this, you can get the required LLC application on your Secretary of State’s website. Just print it out, complete the Articles of Organization and some basic business information, and submit online.

How do I get an LLC for cheap?

Filing your own incorporation application is the cheapest way to form an LLC. Many states post the necessary forms online and some states allow you to submit these forms directly online.

If you prefer not to file the application yourself, an incorporation service may be another option for inexpensive business formation.

For example, Inc Authority provides free LLC formation in 3 easy, online steps. These include choosing your state, entering your business name and forming your new LLC.

What are some of the advantages of forming an LLC for income tax purposes?

LLCs are taxed by States and the IRS based on adjusted gross income of the LLC owners. There are many tax benefits that can be achieved by forming an LLC. Some major benefits include:

Flexibility: LLCs can decide how they are taxed. For example, you can choose whether it is better to file your taxes as a disregarded entity (which is treated the same as a sole proprietor) or to choose corporate taxation. This decision depends on how much income you personally want to take and how much you plan to reinvest in your business.

Leasing assets: You can lease your personal assets to your corporation. This is a business expense that can be used as a write off.

Larger contribution limits: The LLC allows you to create retirement funds and life insurance policies with greater contribution limits. This enables you to save money for the future.

Why are LLCs so popular?

LLCs are popular because they provide several valuable advantages:

• They can be governed informally. While corporation laws require management formalities (such as a BOD, meetings and quorums), LLCs are a lot more informal.
• They have greater flexibility in deciding how to split their financial interests. An LLC can distribute its income to each member equally (based on capital contributions,) or in many other ways. A corporation distributes its income to shareholders on a per share basis.
• They can be a pass-through tax entity without any of the restrictions imposed on corporations.
• In addition, they do not have a residency requirement, they provide limited liability for business debts and obligations, and they can offer a great deal of credibility within the business world. 

How does an limited liability company work?

A limited liability company is one of the easiest business structures to form due to its minimal legal requirements. LLCs separate your business assets from personal assets to prevent your savings, home, retirement and other possessions from being targeted by a lawsuit against your business. Incorporating also creates tax flexibility, credibility and name protection for the business.

What is a Corporation?

Like an LLC, a corporation is a legal entity created separately from those who own and operate it. A corporation’s debts and taxes are separate from its owners, thereby offering the greatest personal liability protection of all business structures. The two most common types of corporations are S and C corporations.

What are the benefits of a C Corporation?    

On average, C corporations pay less in tax than an individual. It’s also the only tax table where the tax rate drops when you start making millions. That’s why every Fortune 500 company is a C corporation.

Additionally, there are no limitations on shareholders. They can live anywhere in the world and be of any entity. Even better, C corps boast fewer criteria than S corps giving you the options you need to meet your objectives.

The main disadvantage of this structure is that it pays tax on its earnings and the shareholders’ dividends. This means a double tax on your corporation’s earnings. This may be a deal breaker for some people.

What are the benefits of an S Corporation?

From tax advantages to flexibility, forming an S corp has many benefits. One such benefit is pass-through taxation. This allows owners to avoid the double taxation of C corps making it a popular choice for small business owners.

Both S and C corps allow for limited liability of the owners, officers, and directors but while C corps have no limitations on shareholders, S corps cap the number of shareholders at 75.

There are also more qualifications your company must meet to elect S corp status

Do LLC’s have to file an annual report?

An LLC may be required to file an annual report with the state government and pay an annual state fee or franchise tax.

Related Articles:

.

Share this article: