What is an LLC?

What is an LLCAre you considering starting a limited liability company (LLC), but you need more information before doing so?

There are a lot of great benefits to owning an LLC, but it’s important to have a full understanding of both the advantages and disadvantages of this business structure before deciding if it’s right for you.

LLC Basics

Ownership and Management

An LLC can be owned by one or many people depending on the specific business. Multiple LLC owners are typically referred to as members. Additionally, an LLC can either be managed by its member(s) or by a separately selected manager, depending on how involved the ownership chooses to be in day to day business operations.

 

Operating Agreement

An operating agreement lays out the important details of a business and its operation. It will include your membership structure, ownership type, and any details related to decision making within the business.

Although only a handful of states expressly require LLCs to file an official copy of their operating agreement, having one in place is highly recommended for both ease of operation and to avoid legal or other problems you may encounter in the future.

 

Registered Agent

Every LLC must designate a registered agent. A registered agent is a person or company that receives important legal documents on your behalf. The registered agent needs to be located in your LLC’s state of formation, as they serve as the point of contact between the state and your company.

Having a registered agent ensures there is no confusion regarding where important company correspondence should go, especially in the event of a lawsuit.

 

Employer Identification Number (EIN)

An Employer Identification Number (commonly referred to as an EIN) is a necessity if you want to be able to hire employees, open a business bank account, or file taxes related to your LLC. You can get an EIN from the Internal Revenue Service for free on their website.

Advantages of an LLC

A limited liability company is an excellent business structure that offers a number of advantages. Owners can find benefits in almost every element of an LLC, from startup to taxation to profit sharing.

 

Personal Asset Protection

The most attractive feature of an LLC is the personal asset protection it provides. By definition, a limited liability company limits your liability to creditors to only your business assets.

In practice, this means that if your company is sued for any reason, creditors cannot go after your personal assets to recoup a debt. Instead of trying to take your house or your car, for example, creditors are limited in their pursuit to the assets of your LLC alone.

 

Pass-Through Taxation

Another major advantage of an LLC is what is commonly referred to as pass-through taxation. This means that business revenue is “passed through” your LLC to its members, who then claim any business profits on their personal tax returns.

The big benefit of pass-through taxation is that your company can avoid “double taxation,” which occurs when business owners are required to pay both corporate and personal income taxes on their company’s earnings.

 

Simple Setup and Maintenance

Establishing and maintaining an LLC is a fairly simply process. While the specifics vary slightly from state to state, most states ask only that you provide a few main details about your company. This usually includes the name and physical address of your LLC, the name and address of the company’s registered agent, and the business’ stated purpose.

Maintaining your LLC is also very straightforward. Most states will not require anything beyond the filing of an annual or biennial report to confirm the details of your business have not changed.

 

Separating Business and Personal Income

Despite the benefit of pass-through taxation, your LLC is, and must remain, a separate entity from yourself and any other members. This means keeping separate bank accounts and financial records can be much easier than with a sole proprietorship, for example, which is merely an extension of its owner.

 

Enhance Your Business Credibility

Owning an LLC can add a great deal of legitimacy and professionalism to your business. When customers are looking for goods or services, they are often more willing to work with an established business than simply an individual. Being able to advertise and hand out business cards with your company’s name and logo verses your personal name can really make a difference.

 

No Citizenship Required

Virtually anyone can start an LLC. There is no need to be a United States citizen, or even a resident, to get your LLC started. You can also form your LLC in any state you choose, even if you don’t live or do business in that state or in the United States at all.

This allows business owners to find the least expensive and most business friendly states to form their companies. This level of flexibility opens up the possibility of business ownership to anyone with the drive and resources to make it happen.

 

Be Your Own Boss

The LLC is a business entity that can be formed and maintained by one person. If you’re a self-starter, or if you simply prefer to work alone, an LLC allows you to make all of your own decisions as a business owner. Aside from the legal structure, a single-member LLC has quite a bit in common with a sole proprietorship.

 

Flexible Structure

LLCs are far more flexible regarding several structural elements than pretty much any other business type in America. One important aspect of this flexibility is the way owners can share profits as they see fit. In a partnership, the partners split profits equally.

Corporations pay dividends based on stockholder interests. LLCs, however, can divide profits however they please. For example, if one member puts in more time running the LLC than the other member(s), that individual can receive a larger percentage of the profits.

A company may also choose to split profits based on how much each member invested in getting the company running. Whatever works best for your LLC is legally acceptable.

Disadvantages of an LLC

While an LLC offers many advantages, there are, of course, some drawbacks. Depending on the specifics of your business, an LLC may not be the best choice when it comes to choosing a business structure that protects your interests and maximizes your profits.

 

Cannot Issue Stock

One major disadvantage of an LLC is that, unlike corporations, they cannot issue stock. While an LLC has a lot of flexibility in terms of how profits are divided among members, an LLC’s ownership cannot sell shares of its company in the way a corporation can.

 

Variable Rules

Unlike some other business types, the rules governing forming and maintaining an LLC are determined at the state level. Although most states have fairly similar requirements, there are still essentially 50 different sets of guidelines for creating and running LLCs in the United States.

While this may not affect a small LLC operating in one or two states, if you plan to conduct business across the country, keeping track of even small details, like annual reporting dates, can become burdensome.

 

Piercing the Corporate Veil

While an LLC is designed to protect your personal assets by establishing what is known as the corporate veil, it does not unequivocally guarantee this protection.

If you fail to maintain your LLC properly, the corporate veil can be pierced and creditors can come after some of your personal possessions. There are several ways in which your corporate veil can be pierced, including failure to keep your business and personal assets separate, commission of fraudulent activities, or failure to pay outstanding debts.

 

Self-Employment Tax

One negative aspect of pass-through taxation is the fact that LLC profits claimed on a member’s personal tax return can be subject to self-employment tax.

This tax rate, which all self-employed, freelance, and contract workers pay annually, requires an individual to pay both the employer and employee shares of Social Security and Medicare taxes. In total, the self-employment tax rate is 15.3%.

To be clear, not all LLC members are required to pay self-employment tax, but many are. If you’re unsure whether this tax applies to you or not, a tax professional can help you determine your tax liability.

 

Limited Lifespan

In some parts of the country, an LLC may cease to exist if a member leaves the company. While this is not uniform across the country, and is not particularly common, it is a very serious manner that you should clarify with your state of formation before registering your LLC.

Final Thoughts

The limited liability company is a highly popular business structure because of its flexibility, and the way it combines some of the best elements of partnerships and corporations. While it is the ideal choice for many different businesses, there are circumstances in which another structure may be more beneficial for your business.

If you would like more information on any of the aspects of LLCs discussed in this article, please explore the wealth of information we have available to you.

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