What Is a Limited Liability Company (LLC)?

Limited liability companies (LLCs) are a US-specific form of private limited companies. In this business structure, owners are protected from some or all of the company’s liabilities and debts. LLCs are hybrid legal entities that combine a corporation’s characteristics with a sole proprietorship or partnership.

The primary characteristic a limited liability company (LLC) shares with a corporation is limited liability. With a partnership, this trait is the availability of flow-through taxation. This means that an LLC’s losses, gains, credits, and other taxable items pass through to the members and are taxed accordingly as part of their income.

How Do LLCs Work?

LLCs are business structures permitted by state statutes. However, each state may enact different regulations for them, so individuals may need to check their local state laws for specific details. The owners of an LLC are known as members, just like the owners of a corporation are shareholders.

As most states don’t restrict ownership, nearly anyone can be a member, such as individuals, corporations, foreign entities, and even other LLCs. Still, some business types such as insurance companies and banks can’t form an LLC. Foreign LLCs have special rules.

This business structure is a formal partnership arrangement that requires the owner to fill a form called articles of organization to found an LLC. Each state has its requirements for this procedure. LLCs provide considerably more protection and flexibility for their members and are easier to set up.

An LLC by itself doesn’t pay federal taxes. According to tax regulations and the choices and number of members, the IRS treats an LLC like a partnership if it has at least two members. If it has one, IRS disregards it as an entity. It can also treat an LLC as a corporation should the owners file specific forms.

Owners don’t get compensation in the form of wages. LLC members have to deduct their salaries from the company’s profits. If it’s a single-member LLC, the owner has to write themselves a business check or transfer the money from the company’s bank account to the personal one. For multi-member LLCs, owners draw from the business account whenever they need it.

How to Form an LLC

The requirements to create an LLC vary per state, but most of them have a common foundation. Individuals first need to choose where they wish to organize their business. Afterward, they can continue and select a name for their LLC.

There are a few things to consider, such as whether it’s a marketable name or easily pronounced and remembered. States place a few restrictions on entity names which have to do with prohibited words and conflicts with other companies.

Once the prospective owner selects the name, they can check its availability with their states’ business entity searcher and reserve it if it’s vacant.

Afterward, the individual must document and fill the state’s articles of organization. Here, they establish the LLC’s members’ powers, rights, liabilities, duties, and obligations. Some essential information that owners must provide is the LLC’s name and the organizer and agent’s name and address.

Once the individual fills the articles of organization and pays a small fee to the state, the company starts to exist. There are additional paperwork and costs on a federal level if the owner needs to obtain an employee identification number.

LLC’s Advantages and Disadvantages.

Besides several aspects already mentioned, such as limiting the members’ liability for acts and debts, there are other advantages to creating an LLC. Members can choose their tax regime. If they fill the necessary forms and comply with the prerequisites, the IRS can tax them as partnerships, sole proprietors, and corporations.

This business structure can have an unlimited number of members, and there isn’t a restriction on citizenship. There is also considerably less administrative paperwork and record-keeping than corporations.

LLCs have perpetual existence. Changing owners doesn’t cause a dissolution, and neither does a member’s death. Even if the last remaining proprietor withdraws or dies, the LLC can continue as long as the LLC can provide a new member.

Although there isn’t a statute that dictates the necessity to provide an operating agreement, owners of multiple-member LLCs that operate without one can encounter problems in the future.

Regardless, as states don’t dictate protective provisions and detailed governance of LLCs, unlike with stock corporations, members have to establish them in accordance with the governing document, which is the operating agreement in most cases.

It’s harder to raise financial capital for LLCs as most investors are comfortable with corporate forms and initial public offerings. The flexible management of this business structure can be both advantageous and detrimental, depending on the LLC and its members.

Variations of LLCs

  • Professional Limited Liability Company (PLLC). It’s an LLC created to provide professional services which require a license. These include doctors, lawyers, chiropractors, architects, engineers, and accountants.
  • However, California and other states don’t permit LLCs to engage in licensed professions at all. Usually, all the members of a PLLC have to practice the same occupation. It’s also essential to note that a member’s liability limitation doesn’t encompass malpractice claims.
  • Series LLC. This particular LLC form allows a company to split its assets into separate series. For example, a series LLC that acquires multiple pieces of real estate can put each in distinct series. Should the lender take possession of one of them, the other properties aren’t affected.
  • Low-profit Limited Liability Company (L3C). It’s a hybrid business structure that bridges the gap between for-profit and non-profit organizations by facilitating expenditures in certain ventures. It does this by simplifying the IRS rules for program-related investments. The L3C combines the tax and legal flexibility of traditional LLCs, the social benefits of non-profit organizations, and the market positioning advantages of social enterprises.
  • In an Anonymous LLC, the state doesn’t make ownership information available publicly. Only a handful of states have laws that allow corporate anonymity, such as Wyoming, Nevada, New Mexico, and Delaware. It’s also quick and inexpensive to do, no different from standard LLCs.

The Bottom Line

A limited liability company is a business structure in the US that combines features of corporations and partnerships. Owners or members aren’t liable for the company’s debts and acts. Statutes and regulations regarding LLCs vary from state to state, but they all have common ground.