What is an LLC?

A limited liability company (LLC) is a type of business structure that protects its members from the company’s debts and liabilities. Members of LLCs can be individuals, companies and even other LLCs. But banks and insurance companies can’t be LLC members.

What is a limited liability company (LLC) and how does it work?

An LLC is a business structure that protects its owners, who are called members, from being held personally responsible for the debts and liabilities of the business. So if the firm goes bankrupt, creditors can’t come after the LLC members because an LLC is legally considered a separate entity from its owners.

LLCs are taxed differently than corporations. A corporation’s profits are taxed at the corporate level and then a second time when profits are distributed to its shareholders. But with an LLC, profits “pass through” to members and are taxed as their personal income. This structure allows businesses to avoid double taxation on the same income. There is no tax on profits at the LLC level, only at the individual member level.

However, LLC rules vary by state. For instance, LLCs in thirteen states and the District of Columbia are required to pay a franchise tax. The amount and way it’s calculated depends on the state.

Why form an LLC?

When starting a business, one of the major considerations is which business structure to choose. The main benefits of forming an LLC are the liability protection it provides for its members and avoiding double taxation. But LLCs also have fewer state compliance requirements than corporations, sole proprietorships and general partnerships.

Existing as an LLC may also provide you with credibility. Some of the largest and most well-known businesses use subsidiaries that operate as LLCs. These include Amazon, IBM and Alphabet — the parent company of Google.

How to start an LLC?

If you’re ready to start an LLC, follow these steps.

1. Decide on a business name. To establish an LLC, you’d need to come up with a business name that doesn’t already exist in the Secretary of State’s records as the name of another domestic or qualified LLC. You can look up your desired LLC on the official website of the state where you’re forming your LLC.
2. Decide what state to form your LLC in. You can form an LLC in any state, even if you are not doing business there. But be sure to look up LLC laws by state, as requirements, rules and taxation laws vary. And if you’re forming an LLC where you’re not doing business, you will need to register as a foreign LLC or foreign qualify with the state that you are doing business in.
3. Get a registered agent. An LLC needs a registered agent who is legally qualified to receive and process legal and tax documents on behalf of your LLC.
4. File your articles of organization. To establish an LLC, you need to file your articles of organization with the corporate filing office or Secretary of State in the state where you’re forming your LLC.
5. Create an operating agreement. Some states require LLCs to have an operating agreement that details how their LLC will be operated and managed.
6. Comply with state regulatory and tax requirements. Legal requirements for LLCs vary by state, so it’s important to know what these are to avoid lawsuits and other damages.
7. Create annual reports. Many states require you to file annual reports detailing basic information about their ongoing business and operations.

What is required to form an LLC?

You’ll need some documents and other items to form an LLC. Here’s a checklist.

• Articles of organization
• Apply for EIN
• Name reservation application
• Operating agreement (in some states)

How much does it cost to form an LLC?

LLC fees vary widely depending on where you live, filing fees can range anywhere from $35 up to $500, but most fall in the $100 range. Recurring fees and report filing requirements can range from $0 to $800 per year. Find out what the requirements are for your state below.⁽¹⁾

LLC pros and cons

Forming an LLC has its ups and downs. Here are some to consider:

Types of LLCs

LLCs can be established in one of different forms, each with its own characteristics.

• Single-member: These are LLCs with one owner. As the sole member of the LLC, the owner generally won’t be held liable for the business’s debts. And the LLCs’ profits are taxed on the owner’s individual tax return.
• Multi-member: This type of LLC has more than one owner, but it enjoys the same benefits as a single-member LLC.
• Series LLC. A Series LLC acts as the parent company of smaller LLCs called series or cells. Each cell has its own members, management structure, assets and purpose.
• Member-managed: In a member-managed LLC, members are in charge of the business’s day-to-day operations. This may include hiring staff, managing financial accounts and more. This structure may work best for members who want to take control of the entire business.
• Manager-managed: A manager-managed LLC is a type of LLC in which the members appoint a manager or team of managers to run daily business operations. The manager can be a member, an outside individual, team or management company. Like any LLC, a manager-managed LLC benefits from limited liability and pass through taxation. This setup may best suit LLCs that want professional management help as they take a role closer to that of an investor.
• Professional LLC: A professional LLC is a type of LLC formed by licensed professionals such as doctors, lawyers and accountants. Some states won’t allow licensed professionals to form LLCs. So they need to form a professional LLC to receive LLC benefits such as limited liability and pass through taxation.

How is an LLC taxed?

Taxes are a complex matter that requires you to speak with a tax professional when choosing how to set up your business for tax purposes. However, here’s a brief explanation of the different tax filing statuses that an LLC may choose:

Single-member LLC

A single-member LLC is considered a “disregarded entity” for federal income tax purposes. This means the IRS would “disregard” the company, so the owner will pay taxes on the entire business’s profits through their own tax returns.

Multi-member LLC

Multi-member LLCs are “pass-through” entities. This means that business profits pass through to the members who pay taxes on their own personal tax returns.

Each member is responsible for paying their share of the company’s profits. Each member is also responsible for the self-employment tax, which includes the company and employer portions of Social Security and Medicare taxes.

Corporation

An LLC can file as a corporation by filing Form 8832, Entity Classification Election. After that, the LLC then files Form 2553 which allows the LLC to file its taxes as an S-corp, but you’ll need to meet certain requirements. An S-corp is a pass-through entity, which means it’s not subject to the corporate tax.

Some LLCs may prefer to file as an S-corp over a traditional partnership to receive more favorable employment taxes. Owners of LLCs taxed as S-corps who work for the business are considered employees, and must pay themselves “reasonable compensation.” Only the wages paid to the owner are considered earned income subject to the FICA tax for Social Security and Medicare.

Other net earnings are considered dividend income and aren’t subject to SECA tax. In this way, LLCs filing as S-corps can employ certain tax planning and deductions that an LLC alone may not be able to accomplish.

As mentioned, taxes are a complex legal matter that requires you to speak with a licensed tax expert.

LLC vs. DBA

An LLC is a business structure, while a DBA — which stands for doing business as — is a kind of designation that permits businesses to operate under a trade name that’s not their legal name.

A DBA is basically a nickname, not a legal business structure, so a DBA alone won’t provide your business with any legal liability protections.

However, an LLC may want to register for a DBA if it wants to operate under a separate business name from its legal name. Many states actually require you to register a DBA if you’ll be doing business under a different name than the actual filing of your LLC.

Other considerations when starting your LLC

While starting an LLC can be an exciting process, there are some points you should keep in mind as you embark on this journey.

• Licenses. Outside of documents and tax forms you may need to start an LLC, you may also need to apply for various licenses and permits. These will vary based on factors like your type of business, state where you operate and more. Check with the Department of Labor, official state websites, the Small Business Administration (SBA) and local business groups to make sure you’re in compliance.
• Registering for an EIN. Many financial institutions require EINs before you can open business bank accounts. And it’s a way to separate company assets from personal finances, which is very important when it comes to liability protection.
• Separating business and personal assets. Mixing company assets with your own may cause you to lose the liability protection offered to LLCs. One way to avoid this is to make sure financial records are attributed to the LLC. Documents like contracts and invoices should have the LLC’s name and detailed business activity rather than that of you or any member.
• Business insurance. Business owners face many risks — from physical damage or lost revenue to personal injury court cases and the responsibility to protect employees. It’s important to consider your business insurance needs before you’re actively doing business.

Bottom line

An LLC protects its members from being held liable for the business’s debts. It also helps companies avoid double taxation. But, it can be costly and time-consuming to form one and the rules for an LLC can vary greatly by state.

Frequently asked questions

How many LLCs can you have?

You can have as many LLCs as you want. But consider the costs and demand to form and operate multiple LLCs.

What is an LLC annual report?

An LLC annual report describes your business operations and other details like the name and address of your registered agent. It’s required by some states.

How much is business insurance for an LLC?

The average cost of a business owner’s insurance policy (BOP) is $57 a month, according to Insureon, a business insurance provider. However, a BOP may not be the only business insurance your business needs. Consult with a licensed insurance agent to determine what types of insurance your business can benefit from.