What is an LLC?
An LLC (limited liability company) is the (relatively) new kid on the block, combining the most significant advantages of partnerships and corporations into one.
Wyoming was the first state to recognize LLCs in 1977. But they caught on like wildfire due to the personal asset protection and tax flexibility they offered.
What are the characteristics of an LLC?
An LLC is a hybrid business entity, combining the positive characteristics of a corporation and a partnership, giving the LLC the best of both worlds.
Like a corporation, an LLC is a legally distinct entity. It can file suit while providing similar liability protection if sued.
Like a partnership, it operates as a pass-through entity with flexible management structure options.
How do you form an LLC?
An LLC comes into being when prospective members file Articles of Organization (or similar documents) with a state's business entities department, usually the Secretary of State.
Members own an LLC, and membership units represent their ownership interests.
An LLC must have at least one member.
How is an LLC managed?
LLCs offer a flexible management structure. They can either be member-managed or manager-managed.
In a member-managed LLC, each member has an equal voice in the company's decision-making processes, much like partners in a partnership. Most limited liability companies are member-managed.
In a manager-managed LLC, the members designate a manager or managers, who may or may not be members, to manage the company, much like officers in a corporation.
LLCs and the IRS
By default, the IRS treats single-member LLCs as disregarded entities (sole proprietorships) and multiple-member LLCs as partnerships, meaning the IRS initially treats them as pass-through entities. Members pay taxes on the profits on their individual tax returns. The company itself does not pay income tax.
However, if the members believe it to be advantageous, the LLC can elect to be taxed as a C or S corporation by filing the appropriate form with the IRS.
Advantages of an LLC
Limited liability protection. The foremost benefit is the liability protection afforded its owners. The members cannot be held liable for company debts and don't have to risk their assets, such as their house or auto, to satisfy those business obligations.
No double taxation. By default, LLCs are not subject to double taxation like C-corporations. The IRS treats an LLC as a pass-through entity, meaning that the LLC is not taxed unless it elects corporate taxation. The individual members report all business profits and losses on their individual income tax returns.
Fewer operational formalities. LLCs require far less paperwork and recordkeeping than a corporation.
Most states don't even require an operating agreement, though it is still good practice to create one so that you can choose the specific rules that will govern your company. State statutes govern the operation of your LLC if you operate without a written operating agreement.
Most states also don’t require LLCs to hold annual meetings required of corporations.
Flexibility. Members can have profits distributed any way they would like. They have the flexibility to do so regardless of their specific ownership interests.
Enhanced credibility. An LLC designation lends credibility to your business by showing potential customers, employees, and vendors that you formally commit to your business.
Disadvantages of a limited liability company
Less developed legal precedent. LLC law is less developed than corporate law, and many issues remain undecided.
Restricted transferability. It is more challenging to transfer your ownership interests.
Difficulty raising capital. Many investors and venture capital firms will only invest in corporations. Thus, raising money for a limited liability company is more challenging.
Industry restrictions. Not all businesses are eligible to form an LLC. Some businesses, e.g., banks and insurance companies, cannot create a limited liability company. And in many states, if you are a licensed professional, such as an accountant or doctor, you cannot form a limited liability company.
