LLC stands for limited liability company. An LLC is a US business structure that offers the personal liability protection of a corporation with the pass-through taxation of a sole proprietorship or partnership.
Forming an LLC is the simplest way of structuring your business to protect your personal assets in the event your business is sued.
LLCs can be owned by one or more people, who are known as LLC “members.” An LLC with one owner is known as a single-member LLC and an LLC with more than one owner is a multi-member LLC.
A limited liability company (LLC) combines attributes from corporations, partnerships, and sole proprietorships: Like a corporation, an LLC provides a personal shield from business debts and liabilities, but its owners pay taxes on the income that comes through the LLC, like partners or sole proprietors. However, running an LLC is significantly easier than running a corporation.
Here are the main features of an LLC
Limited Personal Liability for LLC Owners An LLC can have one or many owners, who are called members. Like shareholders of a
corporation, all LLC owners are protected from personal liability for business debts and claims. This means that if the business itself can’t pay a creditor—such as a supplier, a lender, or a landlord—the creditor can’t legally come after any LLC member’s house, car, or other personal possessions. Because only business assets are used to pay off business debts, LLC owners stand to lose only the money that they’ve invested in the LLC. This feature is often called “limited liability.”
Exceptions to LLC Owners’ Limited Liability
While LLC owners enjoy limited personal liability for many of their business transactions, this protection is not absolute. (This drawback is not unique to LLCs—the same exceptions apply to corporations.) LLC owners can be held personally liable if they:
- Treat the LLC as an extension of their personal affairs, rather than as a separate legal entity (for instance, by commingling personal and business funds
- Intentionally do something fraudulent, illegal, or reckless that causes harm to the company or to someone else
- Personally and directly injure someone
- Fail to pay state taxes and file statements with the state government
- Fail to deposit taxes withheld from employees’ wages, or
- Personally guarantee a bank loan or a business debt on which the LLC defaults
The first exception is the most important. If owners don’t treat the LLC as a separate business, a court might say that the LLC doesn’t really exist and find that its owners are really doing business as individuals, who are personally liable for their acts. To keep this
from happening, make sure you and any co-owners:
- Keep LLC and personal business separate. Get a federal employer identification number, open up a business-only checking account, and keep your personal finances out of your LLC accounting books.
- Fund your LLC adequately. Invest enough cash into the business so that your LLC can meet foreseeable expenses and liabilities.
- Act fairly and legally. Don’t conceal or misrepresent material facts or the state of your finances to vendors, creditors, or other outsiders
- Create an LLC operating agreement. Having a formal written operating agreement lends credibility to your LLC’s separate existence.
The owners of most small LLCs participate equally in the anagement of their business. This arrangement is called “member management.”
There is an alternative management structure—called “manager anagement”—in which you designate one or more owners (or even an outsider) to take responsibility for managing the LLC. The nonmanaging owners (sometimes family members who have invested in the company) simply sit back and share in LLC profits. In a managermanaged LLC, only the named managers get to vote on anagement decisions and act as agents of the LLC.
Choosing manager management sometimes makes sense, but it might require you to deal with state and federal laws regulating the sale of securities
Liability: In a manager-managed LLC, managers and members have personal liability protection
Authority: In a manager-managed LLC, only managers are authorized to enter into deals and bind the LLC to contracts.
Self-Employment Taxes : Nonmanaging members in a manager-managed LLC may not have to pay self-employment taxes; if you are in this situation, consult a tax adviser.
Securities Registration and Exemptions: Membership interests in a manager-managed LLC might be classified as securities because nonmanaging members may be investing their money in a business in which they are not actively participating. If your LLC’s
membership interests are considered securities, you must get an exemption from state and federal securities laws before the initial owners of your LLC invest their money. Fortunately, smaller LLCs usually qualify for securities law exemptions.
For example, SEC rules exempt the private sale of securities from registration if all owners reside in one state and all sales are made within the state; this is called the “intrastate offering” exemption.
Another federal exemption covers “private offerings.” A private offering is an unadvertised sale that is limited to a small number of people (35 or fewer) or to those who, because of their net worth or income earning capacity, can reasonably be expected
to be able to take care of themselves in the investment process. Most states have enacted their own versions of these popular federal exemptions. If you don’t qualify for an exemption to the securities laws, you must register the sale of your LLC’s ownership interests with the SEC and your state.
Unlike a corporation, the LLC itself is not a separate taxable entity. Instead, an LLC has the same tax treatment as a sole proprietor (for a one-person LLC) or partnership (for an LLC with two or more embers). Income “passes through” the LLC to the LLC owners, and the owners report the business’s income on their personal income tax returns.
Types of LLCs
All LLCs offer the same features that make them a unique hybrid of other business entities: limited liability and pass-through taxation. Some LLC types work best for a particular business scenario. Here are the most common types of LLCs.
An LLC is referred to as a “domestic LLC” when it is conducting business in the state in which it was formed. Normally when we refer to an LLC we are actually referring to a domestic LLC.
When an existing LLC decides to open offices or have any other kind of physical presence in a new state, it needs to register in that state as a foreign LLC. For example, if an LLC “organized” in Texas opens a business establishment in Michigan, then your Texas LLC will need to also form in Michigan as a foreign LLC.
A Professional LLC is a limited liability company that is organized to perform a professional service, like a medical or legal practice. To form a professional LLC, it is necessary for certain members of the LLC to possess the necessary state licenses to demonstrate their professional qualifications.
In a professional LLC, the limitation on personal liability does not extend to professional malpractice claims. Therefore, before forming a professional LLC it is advised to seek legal counsel.
A Series LLC is a unique type of LLC where a single “parent” LLC provides limited liability protection across a series of “child” businesses (individual protected series). Also, each “child” business is protected from the liabilities of the other businesses under the single series LLC.
Currently, you can only form a series LLC in seventeen states:
Alabama, Delaware, Washington D.C., Illinois, Indiana, Iowa, Kansas, Minnesota, Missouri, Montana, Nevada, North Dakota, Oklahoma, Tennessee, Texas, Utah, and Wisconsin.
Converting Your Business to an LLC
Converting a sole proprietorship or a partnership to an LLC is an easy way for sole proprietors and partners to protect their personal assets without changing the way their business income is taxed. Some states provide a simple form for converting a partnership to an LLC (often called a “certificate of conversion”). Sole proprietors and partners in states that don’t provide a conversion form must file regular articles of organization to create an LLC. If you are trying to convert a corporation or partnership into an LLC, consult
an attorney before doing so.
How To Form A Limited Liability Company
The best option for LLC formation is to work with a professional. You can find a list of the best LLC services here