What Is a Limited Liability Company (LLC)?

An LLC (limited liability company) is a business structure offering personal liability protection and pass-through taxation. There are many other benefits of forming an LLC such as its simplicity, flexibility, and credibility.

Continue reading to learn more about how LLCs work, whether you should form an LLC, and how to start an LLC.

Should I Form An LLC?

What Are the Benefits of 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 also known as a corporate veil. 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.

Pass-Through Taxation

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. 

Management/Ownership Flexibility

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.

Increased Credibility

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.

What Are the Disadvantages of an LLC?

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

Wondering how to start 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.

The basic steps to starting an LLC are as follows:

  1. Select Your State
  2. Name Your LLC
  3. Choose a Registered Agent
  4. File LLC Formation Documents
  5. Create an LLC Operating Agreement
  6. Get an EIN

You can find detailed steps for your state by reading our How to Form an LLC guide. Simply select your state below:

Or, you can hire a professional LLC formation service to take care of the business formation process for you.

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 start 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 operating agreement is a legal document that provides information about the owners’ duties and responsibilities. It can cover several topics, including:

  • Organization
  • Management
  • Owners’ capital contributions
  • Distributions to owners
  • Membership change procedures
  • Dissolution

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.

LLC EIN

An Employer Identification Number (EIN), also known as a Federal Employer Identification Number (FEIN), or Federal Tax Identification Number (FTIN), is like a Social Security Number (SSN) for your business. EINs are provided by the IRS, and you can apply for a free EIN online through the IRS website. 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:

  • 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.