What Is an LLC?

LLCs are one of the most common business entities.

A limited liability company, or LLC, is the most common business structure adopted by small business owners in the United States. The reason small business owners choose it is due to many factors, including industry, business goals, investors and much more. Specifically, a limited liability company provides certain protections and organizational advantages that other business types may not.

The first step to knowing how to start an LLC is to understand what it is. Find out what an LLC is, how to form an LLC and how it compares to other business structures.

What Is an LLC?

An LLC is one of several common types of business structures that you can choose from when forming your company. You can form an LLC with just one owner, or you can form one with one or more business partners.

The “limited liability” aspect means that an LLC’s owners, called members, are not personally responsible for the company’s debts and lawsuits. For example, if an LLC is slapped with a lawsuit or files for bankruptcy, the owners do not risk their own personal money to pay for the company’s debts or legal settlements.

In terms of taxes, the IRS generally views an LLC similarly to how sole proprietorships, partnerships and S corporations are taxed. Like in those structures, an LLC itself doesn’t pay income taxes. Rather, the LLC members list business profits and losses on their own personal tax returns.

You can choose to have your LLC taxed like a corporation, however, if you want the company itself to pay income taxes. You must file the requisite paperwork with the IRS and comply with corporate tax law in order to do this.

Related: Your Guide to Small Business Taxes

When Is It Best to Form an LLC?

Forming an LLC is best when your business could encounter a reasonable risk of lawsuits or business debts. Forming an LLC protects your personal assets should either such risk emerge as your business operates.

There are several instances in which a business cannot be an LLC. If you’re looking to start a banking, trust or insurance business, you can’t form an LLC. In some states, certain professional businesses like architects, accountants, doctors and licensed healthcare workers cannot form an LLC.

How to Start an LLC

Forming an LLC only takes a few steps, but they are significant ones with legal and organizational ramifications, so it’s important to understand them.

Here’s a guide on how to form an LLC:

1. Choose a Business Name for Your LLC

In the vast majority of states, when you form an LLC, you usually have to include the terms “limited liability company,” “LLC” or “L.L.C.” in the name of your business. The name of your LLC also can’t infringe on the name of a corporation or LLC that’s already a registered business. Since businesses in the insurance and banking industry usually cannot be formed as LLCs, terms like “bank”, “trust” or “insurance” can’t be in the title of your LLC business.

Read: 5 Questions to Ask Before Starting a Business

2. Assign a Registered Agent for Your LLC

When you start a business in any U.S. state, you’ll need to designate what’s called a registered agent, or statutory agent, for your company. A registered agent receives legal mail on behalf of your LLC and forwards documents to you. Your registered agent must be a resident of the state your LLC operates in and be at least 18 years old.

3. Acquire Any Necessary Business Permits and Licenses

Many state and local governments require certain types of businesses to obtain business licenses or permits in order to conduct business. Namely, businesses that sell tangible goods or taxable services must register for a seller’s permit, plus collect and report sales taxes.

Also: What Is a DBA and Does Your Business Need One?

4. File Articles of Organization for LLC

The most important step to make your LLC official is to file Articles of Organization with your state’s Secretary of State office and pay any associated fees. In general, Articles of Organization cover the fundamentals of your LLC, such as the business’s name, location, names and contact information for LLC members and the registered agent you designated for your company.

5. Draw Up an LLC Operating Agreement

This step isn’t a legal requirement, but it makes considerable business sense. An LLC operating agreement enables you to structure financial and working relationships among the members of your LLC. Some of the arrangements covered can include how members divvy up profits, manage the operation’s day-to-day, make business decisions and deal with the arrival and departure of members from the company.

See: 5 Lessons You’ll Learn When Looking for Startup Funding

LLC vs. Other Business Structures

When starting a business, it’s important that you review and weigh your options when it comes to the structure of your business. Forming an LLC is just one way of several different types of business structures you can choose from.

LLC vs. Corporation

An LLC is different than a business that is incorporated, the latter being a corporation rather than a limited liability company. In a corporation, the company issues shares of stocks to the owners, who become shareholders. Owners can transfer their shares with one another, making it a conducive business structure for appealing to outside investors or an initial public offering (IPO).

By contrast, the owners of an LLC each own a designated percentage of the company, often referred to as membership interest. Because of this, membership and membership interest can be tougher to change than ownership of shares in a corporation.

A critical area of difference between forming an LLC and a corporation is in how they are taxed. With a C corporation, you are actually taxed twice: once, when the corporation itself pays business income tax; and a second time when you’re taxed on the dividends the corporation pays out to you.

LLC vs. Partnerships

There are a lot of similarities between a partnership and an LLC. They are taxed in a similar fashion, with income taxes passing through the company where you pay them on your personal tax return. A key difference is that a partnership must have at least two owners, so a sole owner cannot be a partnership, but can be an LLC.

Here are some of the main benefits and drawbacks of forming an LLC:

Pros of an LLC

Here are some benefits of an LLC:

  • Reduce personal legal and financial liability
  • Less complex than corporations
  • Avoid “double taxation” of corporations
  • Make your business official
  • Ownership flexibility

Also: S Corp vs. C Corp — What’s the Difference?

Cons of an LLC

Here are some drawbacks of an LLC:

  • Equity compensation is more difficult
  • Investors often prefer C corporations
  • More expensive to operate than sole proprietorship or partnership

The Bottom Line

There is no “right” answer when it comes to the best business structure for the company you want to start. Forming an LLC is the most common route taken by small business owners. The benefits of a limited liability company include fundamentals like personal protection from legal and financial liabilities, such as lawsuits or debts. LLCs also offer great flexibility with who can be owners and investors. Choosing to the best business structure for your company depends on your needs and business objectives.

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