Your business structure impacts several aspects of your company from legal liability to tax procedures. LLCs are a favorable business structure due to their personal protection and tax flexibility, making them a popular choice for many small businesses.
What Is a Limited Liability Company (LLC)?
A limited liability company (LLC) is a corporate structure that combines features of corporations and partnerships to create what is known as a “hybrid entity.”
As a formal business structure, LLCs are known for their protection of owner’s personal assets which is not a trait of informal business structures such as sole proprietorships. This is because LLCs separate owners from their businesses legally and financially.
A few notable traits of the LLC business structure are:
- Personal asset protection
- Pass-through taxation
- Ownership flexibility
How Do LLCs Work?
LLCs are formed with the state the business is located in and can have an unlimited number of owners.
Once the limited liability company is formed, the business structure separates the company from the owner with what is known as the corporate veil. In this way, LLCs are similar to corporations.
Unlike corporations, however, LLCs can choose how they are taxed. If an LLC chooses not to be taxed directly, the LLC owners or “members” will simply report profits and losses from the business on their personal income tax returns. This is known as “pass-through taxation.”
LLCs also commonly have what is called an “operating agreement” that outlines the ownership and operating procedures of the company.
Pros and Cons of LLCs
Pros
- Personal Liability Protection: Since LLCs separate business and personal assets, business owners benefit protection from personal liability in the event of a lawsuit or similar event.
- Tax Flexibility: LLCs can elect to not pay federal taxes directly, instead reporting profits and losses on the LLC owner’s personal income tax filings, avoiding double taxation.
- Formation is Relatively Easy: Compared to other structures such as corporations, forming an LLC is far more straightforward.
- Operational Flexibility: LLCs provide the opportunity to be member-managed or manager-managed. Plus, many states allow anyone to be a member of the LLC, from individuals to corporations.
Cons
- Dissolution Risk: In some states, if an LLC member exits the company, the business is automatically dissolved making it a risk for some business owners.
- Potentially Higher Fees: LLCs can involve higher fees than a few other business structures such as sole proprietorships and partnerships.
How to Register an LLC
Requirements for registering an LLC varying from state-to-state. However, there are several commonalities.
To register an LLC, you will need to complete and submit formation documents, commonly called Articles of Organization or Certificate of Formation, to your state along with a filing fee. To do so, you will need to have a unique LLC name as well as a registered agent.
CTA: Rather than registering an LLC themselves, many business owners choose to use a service such as Northwest Registered Agent to save time and ensure the filing is completed correctly.
Finally, once you’ve formed your LLC, you will need to obtain an Employer Identification Number (EIN) from the IRS for tax purposes.
Additional Tips:
- Before you form your LLC, be sure to do an LLC name search to ensure that your business name meets the requirements of your state.
- Identify any license, permits, insurance, or tax requirements for LLCs in your state to ensure your business stays compliant.
- Once you’ve formed your LLC, open a business bank account prior to operating to ensure your personal and business assets stay separate.
Conclusion
Limited liability companies (LLCs) are popular business structures, providing asset protection and favorable tax rules for business owners. To form an LLC, be sure to follow the formation steps required in your state to ensure that you’re setting your business up for success from the start.
FAQs
How much does it cost to start an LLC?
The cost to form an LLC varies depending on the state you’re in. Filing fees range from $35 to $500 from state-to-state.
Additional expenses may include publication costs (for New York businesses), business licensing fees, and registered agent fees.
What is the difference between an LLC and a corporation?
LLCs and corporations are both formal business structures. The main differences between the two structures are:
- Corporations are owned by shareholders while LLCs are owned by one or more members
- Corporation ownership is represented by stock in the company whereas LLC management can be distributed freely
How are LLCs taxed?
LLCs have the benefit of choosing how they will be taxed. These companies can either be taxed directly or indirectly. If they opt to be taxed indirectly, profits and losses from the company will be taxed on the owner’s personal income tax returns.
What are the annual requirements for LLCs?
Many LLCs are required to submit an annual report (or some state-specific version) to their state to provide updates on financial data, owner activity and information, as well as the name and address of the company’s registered agent.
Some states such as New York and California also require LLCs to pay annual fees.
