What is an LLC and how do I form one?

What is a Limited Liability Company (LLC)?

A Limited Liability Company (LLC) is a type of business structure that is recognized by state law, as explained by the Internal Revenue Service (IRS). It is a popular choice because it allows you to combine some of the best features of both corporations and partnerships.

One of the main benefits of an LLC, according to the Small Business Administration (SBA), is that it protects you from personal liability in most situations. This means that if your business faces bankruptcy or lawsuits, your personal assets, such as your car, house, and savings accounts, are generally not at risk.

Who can own an LLC?

Most states are flexible about who can own an LLC. The IRS notes that members, or owners, can include individuals, corporations, other LLCs, and even foreign entities. This broad ownership allowance makes LLCs accessible to a wide range of entrepreneurs.

Additionally, many states permit “single-member” LLCs, meaning an LLC can have just one owner. However, there are a few types of businesses that generally cannot be LLCs, such as banks and insurance companies.

How are LLCs taxed?

One of the most flexible aspects of an LLC is its tax treatment. The IRS explains that depending on the elections made by the LLC and the number of its members, an LLC can be treated as a corporation, a partnership, or as a “disregarded entity.” A disregarded entity means the business income and expenses are reported on the owner's personal tax return.

For federal income tax purposes, a domestic LLC with at least two members is typically classified as a partnership by default. If an LLC has only one member, it is generally treated as an entity disregarded as separate from its owner. This means profits and losses can pass through to your personal income without facing corporate taxes, as the SBA points out.

If an LLC does not want to accept its default federal tax classification or wishes to change it, it can file Form 8832, Entity Classification Election. This form allows the LLC to elect to be treated as a corporation instead. If a qualifying LLC elected to be an S Corporation, it should file Form 1120-S.

It is important to note that members of an LLC are considered self-employed. This means they are responsible for paying self-employment tax contributions, which go towards Medicare and Social Security, as highlighted by the SBA.

What are the advantages of an LLC?

The primary advantage of an LLC is the personal liability protection it offers. The SBA states that your personal assets, such as your vehicle, house, and savings accounts, are protected from business lawsuits or bankruptcy. This separation of personal and business finances provides a significant layer of security.

Another key advantage is the flexibility in tax treatment. As the IRS explains, an LLC can choose to be taxed in several ways: as a corporation, a partnership, or as a disregarded entity. This allows profits and losses to pass through to your personal income without facing corporate taxes, which can simplify tax filing for many small businesses.

What are the disadvantages of an LLC?

While LLCs offer many benefits, there is one notable disadvantage for members. The SBA points out that members of an LLC are considered self-employed. This means they are responsible for paying self-employment tax contributions, which go towards Medicare and Social Security.

How do I form an LLC?

Forming an LLC generally involves several steps at the state level. The SBA advises that if your business is an LLC, you will likely need to register with any state where you conduct business activities. This ensures your business is legally recognized where it operates.

Before you file, you will need a registered agent in your state. The SBA states that if your business is an LLC, corporation, partnership, or nonprofit corporation, you’ll need a registered agent in your state before you file. After that, you will file a document called “articles of organization,” which is a straightforward document that outlines the basic information about your LLC.

Finally, it is important to create an operating agreement. This document describes the structure of your company’s financial and functional decisions.

Common questions