LLC Pros and Cons: Should I Form An LLC?
The LLC structure has several benefits for businesses:
- Personal asset protection
- Pass-through taxation
- Simple business structure
- Management/ownership flexibility
- Increased Credibility
Personal Asset Protection
One of the most important benefits of LLCs is that they offer their owners personal asset protection. This is where the “limited liability” part of the name comes from. This means that if the business is sued or goes into debt, the owners are not in danger of losing their personal assets. This is not the case with sole proprietorships and partnerships.
LLCs are eligible for pass-through taxation. This means that the business’ profits “pass through” directly to the owners without being taxed first. Owners then claim the profits on their personal tax returns. This differs from corporate taxation, in which the profits are taxed at both the corporate level and on the owners’ tax returns.
Simple Business Structure
LLCs are generally much easier and less complicated to form than corporations. They also come with less paperwork and expenses as well as fewer formal requirements.
An LLC may be owned by one person (a single-member LLC) or by multiple people (a multi-member LLC). Multi-member LLCs may be managed by the members (member-managed) or they can appoint a manager of the LLC (manager-managed).
Read more about the differences between member-managed and manager-managed LLCs — and which one might be best for you — in our guide to management by members or managers.
Forming an LLC can help a business seem more professional than if it were a sole proprietorship or partnership. Customers, and potential customers, may feel more comfortable doing business with you if they see your company registered as an LLC.
Banks also tend to be more willing to do business with LLCs than with sole proprietorships or partnerships, which can increase access to business loans and other lines of credit.
The LLC structure does, however, come with some potential disadvantages:
- If an LLC is taxed as a pass-through entity, owners must pay income tax on the company’s profits even if they don’t receive a personal disbursement payment.
- LLCs also may find it harder to raise capital from outside investors than corporations. Investors typically prefer the stock structure of corporations.
- Some states levy additional taxes or higher fees on LLCs than they do on corporations.
How Is an LLC Taxed?
LLCs are subject to pass-through taxation by default. This means that the company’s profits (or losses) pass through to the owners and then get taxed on their individual tax return. This differs from corporations, which must pay a corporate tax rate on profits before distributing them to owners. Those net profits are then taxed again on each owner’s individual tax return — a process often referred to as “double taxation.”
Something important about pass-through taxation is that the Internal Revenue Service (IRS) does not make a distinction between profits distributed to members and retained earnings. This means that even if the LLC reinvests some of its profits into the business instead of paying them out to its owners, the owners must still pay taxes on that amount. Pass-through entities also pay a higher rate of employment tax.
One way around both of these potential downsides is to elect to be taxed as an S corporation (S corp). LLCs also may elect to be taxed as a C corporation (C corp) if they prefer. The current corporate tax rate is 21%. Read this LLC tax guide to learn more about tax options for LLCs.
One relatively recent change in LLC taxation is the 20% pass-through deduction that came into effect with the Tax Cuts and Jobs Act of 2017. This allows LLC owners to deduct up to 20% of the company’s qualified business income on their personal tax returns.
In addition to these federal taxes, some states require LLCs to pay a “franchise tax.” This varies by state and can be a flat-rate tax or based on the LLC’s assets or earnings. To learn more about state taxes, visit our guide to business taxes by state.
Forming an LLC
While the process varies from state to state, forming an LLC generally is a fairly simple, straightforward, and inexpensive process. Depending on the state, owners can typically form an LLC for between $50 and $500.
You can find detailed steps for your state by reading our How to Form an LLC guide and selecting your state from the drop-down menu.
One of the first steps to starting an LLC is choosing a business name. To learn more about naming your business, read our How to Name an LLC guide.
LLC Articles of Organization
To form an LLC, you must file the Articles of Organization (sometimes called a Certificate of Organization or a Certificate of Formation) with the government in the company’s home state. The required information varies by state, but generally includes at least some of the following:
- Name of the LLC
- Whether it’s member-managed or manager-managed
- Effective date and duration of the LLC
- Names and addresses of the members
- Name and address of the LLC’s registered agent
LLC Operating Agreement
The LLC’s operating agreement is a legal document that provides information about the owners’ duties and responsibilities. It can cover several topics, including:
- Owners’ capital contributions
- Distributions to owners
- Membership change procedures
For a more detailed overview of LLC operating agreements, read our What is an Operating Agreement article. If you want to create your own operating agreement, check out this free LLC operating agreement template.
An Employer Identification Number (EIN) is a federal tax ID number provided by the IRS. Most businesses — except sole proprietorships and single-member LLCs with no employees — must have an EIN.
Even if you own a single-member LLC and don’t have any employees, you may still want to get an EIN in case you ever decide to hire anyone in the future. An EIN also can help you obtain a business bank account and improve your personal liability protection.
Types of LLCs
LLCs come in several different types. Note that a single LLC can (and likely will) fall under more than one of these classifications:
- Single-Member LLC: This is an LLC with only one owner.
- Multi-Member LLC: This is an LLC with multiple owners.
- Member-Managed LLC: This is an LLC managed by its members.
- Manager-Managed LLC: This is an LLC managed by a manager appointed by its members.
- Series LLC: This structure allows for legally separate LLCs to nest under a “parent” LLC while streamlining the formation process. In this structure, each separate LLC has liability protection from the others.
- PLLC: A professional limited liability company (PLLC) generally offers certain services requiring a license or other expertise (e.g., attorneys, architects, medical professionals, etc.).
- L3C: A low-profit limited liability company (L3C) typically focuses on social benefit activities rather than maximizing profits.
- Domestic LLC: This is an LLC that conducts business in the state in which it was formed.
- Foreign LLC: This is an LLC that conducts business in a state other than the one in which it was formed.
Best States to Form an LLC
It's true that some states have a more business-friendly reputation. Several states — particularly Wyoming, Nevada, and Delaware — have relaxed or beneficial business laws.
Unless your LLC is physically located in one of these states, the benefits probably don’t outweigh the added complication. You can read an LLC formation guide for your state by selecting it from the drop-down menu on our How to Form an LLC guide.
How much does it cost to start an LLC?
The cost of forming an LLC varies by state but generally ranges from $50 to $500.
What does limited liability mean?
Limited liability refers to the owners’ personal financial responsibility for an LLC’s debts. If an LLC lost an expensive lawsuit, for example, its owners’ personal financial assets would not be in danger.
What is an LLC good for?
LLCs are good at protecting their owners’ personal financial assets in the event the company goes into debt. They also provide a fairly simple business structure to set up and maintain.
Are there any downsides to forming an LLC?
One potential downside of an LLC is that owners must pay tax on retained business earnings. LLCs also may find it harder to raise capital than corporations.
Do I need a lawyer to start an LLC?
You typically don’t need a lawyer to form an LLC. The process is relatively simple, and you can follow this How to Form an LLC guide for your home state.
What is a registered agent?
A registered agent is a third-party professional that acts as your company’s representative to the state. They help keep your paperwork organized so you stay in compliance with state regulations. Read more on our What is a Registered Agent guide.
Do LLCs have shareholders?
LLCs don’t have shareholders and don’t sell stock. They are owned by their members.
Do LLCs have a board of directors?
Unlike corporations, LLCs are not required to have a board of directors. However, there is no rule against having directors if desired.
How do I name an LLC?
There are many factors to consider about How to Name an LLC. You must think about branding, name availability, and the naming rules in your LLC’s home state.
For more information about how to name an LLC in your state, select the state from the drop-down menu on this How to Name a Business guide.
Where should I form my LLC?
While some states may have “friendlier” business laws than others (e.g., Wyoming, Nevada, and Delaware), it’s generally best to form your LLC in the state where it will conduct business.
Should I form an LLC?
Every business is different, so there’s no general answer to this question. An LLC may be a great option for your business, but you should read through our guides to help you decide if an LLC is the right fit for you.