Limited Liability Company (LLC)

A corporate structure that shields its owners from personal accountability

In the United States, a limited liability company (LLC) is a corporate structure that shields its owners from personal accountability for the firm's debts or liabilities. 

Limited Liability Company (LLC)

Limited liability companies are hybrid businesses that combine the advantages of a corporation with those of a partnership or a single proprietorship.

In the United States, there are around 21.6 million limited liability companies (LLCs). In comparison, there are around 1.7 million regular C-Corporations and over 23 million sole proprietorships in the United States. 

Since 2004, the number of domestic LLCs has increased year over year, according to IRS figures.

While the limited liability aspect of an LLC is comparable to that of a corporation, flow-through taxes for its members is a feature of a partnership rather than an LLC.

Individuals, businesses, foreigners, foreign entities, and even other limited liability companies can be members in many states since ownership is not restricted. However, some businesses, such as banks and insurance firms, are unable to incorporate Limited Liability Companies.

Taxes

It is a type of legal partnership that involves filing articles of incorporation with the state. It is less complicated to form than a corporation and offers investors greater freedom and security.

They have the option of avoiding paying federal taxes directly. Instead, the earnings and losses are recorded on the owners' tax returns. 

Creditors may be able to pursue members if fraud is discovered or if a corporation fails to satisfy its legal and reporting obligations

The Advantages and Disadvantages of a Limited Liability Company

Thumbs

Advantages

  • Fewer corporate formalities 

Corporations are required to have regular board and shareholder meetings, record documented corporate minutes, and file yearly reports with the state. An LLC, on the other hand, does not require its members and administrators to meet on a regular basis, which eliminates hassles and paperwork.

  • No ownership restrictions 

S-corporations are limited to 100 stockholders, and each stockholder must be a natural person who is a United States resident or citizen. A Limited Liability Company is not subject to these limitations.

  • Ability to use the cash method of accounting

Unlike C-corporations, which are frequently required to use the accrual method of accounting, most limited liability firms can utilize the cash method. This implies that money does not become yours until you get it.

  • Ability to place membership interests in a living trust

Members of a limited liability company have the option of putting their membership interests in a living trust. It's tough to put S-corporation shares into a living trust.

  • Ability to deduct losses

Members who are active participants in the business can deduct the organizations operating losses from their regular income to the degree allowed by law. Operating losses can be deducted by S-corporation owners but not by C-corporation shareholders.

  • Tax flexibility 

For tax reasons, Limited Liability Companies are classified as "pass-through" entities, similar to a sole proprietorship or partnership. They avoid double taxes as a result of this. 

Furthermore, the owner is exempt from paying unemployment insurance taxes on their wages. They can, however, decide to be taxed as a corporation, whether as a C-corporation or an S-corporation.

Tax Return

  • Profits subject to social security and medicare taxes

The owners may pay more taxes than owners of a corporation in specific circumstances. Salaries and profits earned are subject to self-employment taxes, which are presently at 15.3 percent. 

Only salaries (not profits) are liable to such taxes in a corporation. This disadvantage is especially pronounced for owners who earn less than $97,500 in the 2007 tax year.

  • Owners must immediately recognize profits.

A C-corporation is not required to transfer earnings to its stockholders as a dividend right away. This implies that C-corporation stockholders are not always taxed on the company's profits. 

The earnings are immediately included in a member's income since it is not subject to double taxation.

  • Fewer fringe benefits

Employees of the entity must count fringe benefits such as group insurance, medical reimbursement schemes, medical insurance, and parking as taxable income. 

Employees who possess more than 2% of an S-corporation are subject to the same rules. On the other hand, employees of a C-corporation do not have to disclose their fringe benefits as taxable income.

Forming a Limited Liability Company

Puzzle

Step 1: Choose a state in which to form your LLC

Although they may be formed in any state, even if they won't be doing any business there, most owners opt to register one in the state where they expect to do business, which is often their home state. 

One reason for this is that if it is formed in a state where it will not be doing business, the entity will be required to register as a foreign LLC (also known as a foreign qualifier) in the state where it will be doing business, which can increase the formation and administrative costs.

Step 2: Choose a name for your Organization

To create the Organization, you must pick a name not already registered with the Secretary of State as the name of another domestic or qualified LLC or other business organization. 

ID

Many sole owners utilize a registered "doing business as" (DBA) name or trade name, which they may desire to use as the legal name of their organization.

Step 3: Choose a registered agent

You must have a registered agent in the state of formation or qualifying if you are founding an LLC or registering an existing LLC to do business in a foreign state. 

Many new company owners are either unaware of the phrase "registered agent" or are unsure of what a registered agent does.

On behalf of a Limited Liability Company, a registered agent, also known as an agent for service of process, receives critical legal notices and tax paperwork. 

These include significant legal papers, notices, and communications (such as yearly reports or statements) mailed by the Secretary of State and tax paperwork mailed by the state's department of revenue.

Step 4: Prepare an operating agreement.

Almost every state requires an LLC operating agreement. Although it is permissible in most jurisdictions to have an oral operating agreement, it is strongly advised that every organization have a documented operating agreement. 

As the name indicates, it is an agreement among the members and between the entity and the member or members about how the company will be run. 

Even if you're the only one in the group, having an operating agreement is essential. It demonstrates that you respect the organization's separate existence (and can help avoid piercing the veil). 

It allows you to put in writing what you want to happen in certain situations and to opt-out of certain default provisions of the LLC statute that you may not want to govern the company.

Step 5: File your LLC with your state

To legally establish your new organization, you must file the formation paperwork (also known as a Certificate of Organization, Certificate of Formation, or Articles of Organization) with the Secretary of State's office or the agency in charge of company files in the state where you are creating it. Filing fees differ from state to state in the United States.

Step 6: Obtain an EIN

You must apply for an employer identification number with the Internal Revenue Service after forming the business organization (EIN). This is the number that will appear on all of your LLC's bank accounts, as well as income and employment tax returns.

Papers

In addition, you must apply for a sales tax identification number from the state's tax department and register with the state's labor department in each state where the organization will be conducting business.

Step 7: Open a business bank account

This is not a legal necessity, but it is an important best practice for anybody forming a Limited Liability Company. 

When evaluating whether to pierce an LLC's veil and hold the member accountable for the organization's obligations, this is one of the most important considerations judges evaluate. 

A business credit card may also be utilized to segregate personal and company purchases while also assisting in the development of business credit.

Step 8: Register to do business in other states (if necessary)

If the organization you founded intends to do business in more than one state, you'll need to register in each " foreign " state. This usually necessitates submitting a request for authorization to the Secretary of State.

In many cases, a Certificate of Good Standing is also necessary. A registered agent must be appointed and maintained by the company.

FAQ

Venture Capital Course

Everything You Need To Break into Venture Capital

Sign Up to The Insider's Guide by Elite Venture Capitalists with Proven Track Records.

Learn More

Researched and authored by Tanay Gehi | Linkedin

Edited by Colt DiGiovanni | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: