Business Planning

What is an LLC and is it Right For Your Business?

Read Time: 10 min

It’s natural for business owners to worry about liability. No matter the nature of your enterprise, there’s something that can go wrong and result in legal liability. In such situations, you do not want your personal assets vulnerable to lawsuits and creditors. This is why a limited liability company, commonly known as an LLC, is such a popular business structure, as it separates the business’s assets from the personal assets of the business owner(s). This ensures a business owner’s personal assets won’t be vulnerable to their business’s lawsuits or creditors.

Below explores what is an LLC in-depth to help you determine if it’s the optimal structure for your business.

What is an LLC and How Does it Work?

woman giving a presentation in a corporate meeting on what does LLC mean

The IRS defines a limited liability company as a “business structure allowed by state statute.”[1]Internal Revenue Service. “Limited Liability Company (LLC)“. Accessed February 9, 2022. State statutes permit most businesses to operate as LLCs, with some restrictions. Particularly, state statutes do not allow banks and insurers to operate as LLCs.

There are certain industries in which limited liability companies are the standard business entity, such as commercial and residential real estate rentals. Many LLCs are sole-owner businesses or partnerships, but larger enterprises may also be LLCs.

Set up this business structure in your state by visiting the Secretary of State’s website and locating the LLC articles of organization certificate of formation. In most states, you can complete the entire process online. The forms vary by state, but you will generally need:

  • business name
  • business address
  • registered agent
  • business purpose
  • business duration

When complete, submit the documentation along with a filing fee. If approved, the state sends you a formal registration certificate.

What does LLC stand for?

LLC stands for “limited liability company.” The name is self-explanatory, as it means the owner(s) of the business are not personally responsible for the business’s liabilities or debts. Thus, the business owner(s) have limited liability.

Types of LLCs

Limited liability companies are not one-size-fits-all. You can find an LLC designed to meet the particular needs of your business. Below are different types of LLCs you may want to consider for your business.

Professional LLC

Doctors, lawyers, and similarly licensed professionals may set up professional limited liability companies for asset protection. However, professional limited liability companies are not available in all states.

Domestic LLC

You form a domestic limited liability company within the business’s home state. Regulations governing limited liability companies vary by state.

Foreign LLC

A foreign limited liability company is one formed outside of the state in which you do business.[2]Nolo. “Foreign Limited Liability Company“. Accessed February 9, 2022. For instance, if your business is initially formed in New Jersey, New Jersey is its domestic state. If you want to do business in neighboring Pennsylvania, you must register your LLC as a foreign LLC to ensure you are meeting the Keystone State’s tax and regulatory requirements.

Foreign limited liability companies do not refer to businesses conducted in other countries, just other states.

Series LLC

A series limited liability company refers to a type of LLC in which the “parent” LLC has one or more series established under it.[3]Nolo. “Single Member Limited Liability Companies“. Accessed February 9, 2022. Each series, or cell, has characteristics differing from the parent LLC. Every cell can have its own members, assets, investments, objectives, and the like. The cell is liable only for its own obligations and debts. It is a flexible but somewhat complex business structure.  

Series limited liability companies are available in relatively few states. These include:

  • Delaware
  • Illinois
  • Iowa
  • Nevada
  • Oklahoma
  • Tennessee
  • Texas
  • Utah

Puerto Rico also allows the formation of series limited liability companies. Other states have options functioning similarly to series limited liability companies. California does not permit series limited liability company formation. However, it is possible to form a series in another state and do business in California.

Single-member LLC 

A single-member limited liability company provides the protection of an LLC, yet allows you to file as a “disregarded entity” on your personal tax return.[4]Internal Revenue Service. “Single Member Limited Liability Companies“. Accessed February 9, 2022. The IRS permits single-member limited liability companies to file either as a corporation or as an entity separate from the individual for income tax purposes. 

LLC vs Other Business Structures

Choosing the right business structure for your enterprise is vital. To help you choose, below compares limited liability companies to other popular business structures. However, we advise your accountant guide you in this endeavor, as they have a more specific understanding of your business’s needs.

LLC vs corporation

Members own limited liability companies, whereas shareholders own corporations. Both of these business structures provide personal asset protection from creditors and legal liability. Creating a limited liability company requires less paperwork than creating a corporation. Overall, creating an LLC is an easier process.

Corporations require officers, board members, shareholders, and related meetings. A limited liability company requires none of that. In comparison to a corporation, a limited liability company is a simple business structure with few administrative burdens. 

The IRS allows the taxation of a limited liability company as a corporation if members so choose.

LLC vs partnership

two business people shaking hands after leaning about limited liability company

A limited liability company with more than two members is automatically considered a partnership by the IRS unless it files Form 8832, allowing it a corporation classification.

Partnerships do not require any paperwork, per se, although you should have a partnership agreement. A limited liability company must file articles of organization in compliance with the rules of its state.

Most partnerships are general partnerships, in which each partner is involved in running the business’s day-to-day operations. To protect the partnership from liability, is it crucial to form a limited liability company or a corporation.

Limited partnerships refer to partners who invest in the business, but do not have an operational or managerial role. Their liability is limited to the amount of their investment.  

LLC vs sole proprietorship

In regards to sole proprietorships, the consideration of liability is that you are the business and the business is you. Your personal assets are vulnerable to creditors.

With a limited liability company, you are not personally liable for business debts. Should your business fail or be sued, your personal assets are safe from creditors.

LLC Advantages and Disadvantages

As with every business decision, there are advantages and disadvantages in choosing this business structure. Below first explores the good news (the advantages) before diving into the bad news (the disadvantages) of limited liability companies.

Advantages

While limited liability is a major advantage of limited liability companies, so much so that it’s right there in the name, there are numerous advantages to limited liability companies. We explore some below.

Limited liability

In the event of business failure and/or legal issues, your personal asset are protected. Limited liability companies ensure your personal assets and business assets are officially divided, thus protecting each from the consequences of the other.

Flexible management

Limited liability companies may be managed by an individual, partnership, trust, or corporation. There is no member limit in regards to the management.

Pass-through federal taxation

Under a limited liability company, taxes are not paid as a business entity. Income is reported and taxes are paid on the personal income tax returns of the business owner(s). This concept is called “pass-through federal taxation.” It’s executed to avoid double taxation in the form of the business and business owner(s) paying taxes on the same business income.

Simple startup

Comparative to other business structures, there’s minimal paperwork required to establish this business structure.

Disadvantages

While there are many alluring advantages to limited liability companies, they aren’t without drawbacks. Below are a few disadvantages associated with limited liability companies.

Limitations due to limited liability

You must ensure there is no commingling of personal funds and business funds. In being an LLC, your business requires its own checking accounts. Any commingling threatens your limited liability status.

LLC member vs manager

Limited liability company owners are called members. As per the IRS, members may consist of individuals, corporations, other LLCs, or foreign entities. When member-managed, all members participate in the day-to-day running of the business.[5]Legal Zoom. “The Definition of an LLC Managing Member“. Accessed February 9, 2022. There is no limit on the number of LLC members.

Besides the member-managed structure, there is the manager-managed structure. In a manager-managed structure, the members simply own the business. They’re not involved in daily management. They cannot enter into contracts on behalf of the business, as that is the domain of management. Managers are not members. They may consist of individuals, multiple people, or a professional entity. State laws determine who may or may not serve as managers.

LLC Taxes

For tax purposes, the IRS treats an LLC in one of the following ways, depending on the number of members or the LLC elections[6]Internal Revenue Service. “LLC Filing as a Corporation or Partnership“. Accessed February 9, 2022.:

  • Part of the owner’s tax return
  • C corporation
  • Partnership

Should You Form an LLC?

If you’re starting a business, you must decide on the business structure. There’s a reason an LLC is among the most popular types of business structures. They are among the simplest structures to form and maintenance is relatively straightforward. However, you should investigate all types of business structures prior to making a decision to ensure an LLC is the best choice for your purposes.

Where Should I Form My LLC?

While most owners form an LLC in the state where they conduct business, there are other options to consider. Below explores those options.

In-state vs out of state

You can form an LLC in any state, even if that is not your business’s base. However, for most people, forming an LLC in the state in which the business is physically located and performs the bulk of its business makes the most sense.

Most Popular States

States with certain tax advantages are the most popular locations for forming an LLC. A list of these states and their advantages is below.

Delaware

Delaware does not tax out-of-state income. You do not have to pay taxes on out-of-state income. This is the case even if your business is primarily conducted in another state.

Wyoming

Along with no business income tax, Wyoming offers lifetime proxy. That means you can appoint someone else to represent your shares and vote on your behalf, allowing you to remain anonymous.

Nevada

There is no tax on business income or capital gains in Nevada. There is also no inheritance tax.

LLC FAQs

In case you still have questions regarding limited liability companies, below explores some frequently asked questions on the topic.

What is an LLC operating agreement?

An operating agreement outlines the business’s financial decisions, functionality, and regulations.[7]Internal Revenue Service. “Basic Information About Operating Agreements“. Accessed February 9, 2022. Without an operating agreement, members do not enjoy the personal liability protection that makes limited liability companies an attractive business structure.

How is an LLC taxed?

LLCs serve as pass-through entities for tax purposes. The business itself does not pay taxes on business income. Instead, income is taxed through the individual members’ tax filings. In a partnership, profits pass through to members based on their percentage share of the partnership. However, members can decide if they would rather have the business taxed as a corporation, rather than as a pass-through entity.

The owner of a single-member LLC reports their business income on Form 1040, Schedule C. That’s the same way a sole proprietor reports their income. Should your business generate a profit after business expenses, you pay taxes at your personal income tax rate.

corporate employees reviewing a table scattered with documents explaining what is an LLC

Do I need an EIN for my LLC?

An LLC needs an Employment Identification Number (EIN) if it has employees or is subject to taxes. While a single-member LLC can use the member’s social security number (SSN) in lieu of an EIN, an EIN is necessary if the member wants to open a business bank account in the business’s name. Additionally, some states require the LLCs to have an EIN when reporting state income tax.

What is a registered agent for an LLC?

The registered agent serves as the individual named to receive legal and other documents on the business’s behalf.[8]Legal Zoom. “Why Do I Need a Registered Agent?“. Accessed February 9, 2022. Most states require a registered agent for all businesses outside of sole proprietorships or general partnerships.

What is a domestic limited liability company?

A domestic limited liability company is one formed within your business’s home state. You must have a domestic LLC before branching the business out to other states or foreign countries.

Is an LLC a business license?

No, a Limited Liability Company is a business structure. It is not a business license.

Can an LLC be a nonprofit?

While an LLC can technically be a nonprofit, for practical purposes, that seldom happens.[9]Legal Zoom. “Can An LLC Be A Nonprofit?” Accessed February 9, 2022. All members of an LLC nonprofit must also be a tax-exempt organization, so each member would have to first incorporate as a nonprofit organization, then form the nonprofit LLC. It’s a cumbersome process. There are more straightforward ways to form a nonprofit organization.

Can an LLC own another LLC?

An LLC can own another LLC by setting up a parent LLC with subsidiary LLCs.[10]Legal Zoom. “Can an LLC Own Another LLC?“. Accessed February 9, 2022.

Limited Liability Company: Final Thoughts

Before you can begin accepting payments for the goods or services your business renders, you must decide on the business’s structure. Creating an LLC protects business owners from liability. However, it can prove difficult to attract outside investors. For instance, venture capital money funds only new enterprises structured as corporations. You may find an investor willing to fund your business who becomes an LLC member, but that can become complicated.

When determining the best business structure for your enterprise, discuss the issue with your attorney or accountant. For many sole proprietors, partnerships, and businesses, the LLC makes the most sense.

Article Sources

  1. Internal Revenue Service. “Limited Liability Company (LLC)“. Accessed February 9, 2022.
  2. Nolo. “Foreign Limited Liability Company“. Accessed February 9, 2022.
  3. Nolo. “Single Member Limited Liability Companies“. Accessed February 9, 2022.
  4. Internal Revenue Service. “Single Member Limited Liability Companies“. Accessed February 9, 2022.
  5. Legal Zoom. “The Definition of an LLC Managing Member“. Accessed February 9, 2022.
  6. Internal Revenue Service. “LLC Filing as a Corporation or Partnership“. Accessed February 9, 2022.
  7. Internal Revenue Service. “Basic Information About Operating Agreements“. Accessed February 9, 2022.
  8. Legal Zoom. “Why Do I Need a Registered Agent?“. Accessed February 9, 2022.
  9. Legal Zoom. “Can An LLC Be A Nonprofit?” Accessed February 9, 2022.
  10. Legal Zoom. “Can an LLC Own Another LLC?“. Accessed February 9, 2022.


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