What is an LLC?
LLC is an abbreviation for a limited liability company. It’s a US-specific business structure that appeared back in the 1970s as a response to a quickly transforming business environment.
An LLC is a hybrid business form standing in between disregarded entities and corporations and combining the features of both. To make it clear how it looks in practice, here are the main limited liability company’s characteristics:
- It requires state registration like corporations and exists as an independent entity separate from its owners;
- As the name suggests, it offers limited liability protection keeping the company owners personally non-liable against business commitments, debts, and lawsuits;
- An LLC borrows pass-through taxation from unregistered business forms and is taxed as a disregarded entity by default;
- The number of LLC members is not limited. So, you can form a single-member company with only one owner similar to sole proprietorships. Or you can set up a multi-member LLC with as many co-owners as you deem necessary.
Quick Historical Flashback
The first state that accepted a limited liability company law in 1977 was Wyoming (thus, today this state is one of the most LLC-friendly in the US). Yet, it was only in 1988 that LLCs got up steam since the IRS finally decided how to classify these companies for tax purposes.
During the period from 1988 to 1996, all 50 US states adopted LLC statutes that gave rise to a new era in US business. Now, an LLC is by far the most popular legal structure widely favored in all jurisdictions due to a small business boom.
LLC Pluses
An LLC framework owes its wide popularity to the benefits it offers to private enterprises. Let’s name the major pluses you’ll get and consider how they work from a business perspective.
Personal Asset Shield
Thanks to state registration, limited liability companies become entities that are legally separate from their owners. Likewise, company members are not held liable for the business overdue, indebtedness, and sues unless there is some kind of:
- Fraud;
- Delinquency;
- Violation they are personally involved in.
As a result, personal member property and funds are not associated with business assets and can’t be used as a settlement for a company's debts and lawsuits.
Taxation Alternatives
By default, LLCs are taxed as pass-through entities, with business incomes being taxed under the personal tax returns of the company owners. This allows for avoiding dual taxation and paying levies under lower rates.
At the same time, like no other business forms, LLCs can choose to be taxed as the following:
- S-Corp;
- C-Corp.
This feature allows optimizing taxes for a fast-growing income as well as makes it easier to raise funds to maintain further business upscale.
Simplicity
Though requiring state registration like corporations, LLCs are very easy to organize and entangle neither multiple formalities nor a lot of paperwork and legal routines.
The same is true for the business operation, with a few compliance requirements to observe and no compulsory official meetings to be held or minutes to be maintained.
Flexible Management
Free from the administrative burden of corporate structures, LLCs can be managed and operated as their owners and directors deem necessary. With that, company owners are not obliged to manage the company. They can choose to do the following:
- Serve as LLC directors;
- Hire third-party managers for that purpose.
In multi-member companies, it often happens that owners operate their business supported by hired managers.
Enhanced Credibility
With an LLC, your business gains a formal structure while retaining many perks of unregistered entities. And formal structures feel more reliable and trustworthy not only for customers and clients but also for suppliers, vendors, and creditors.
Speaking of which, while sole proprietorships and partnerships have low chances to get business loans, LLCs are more eagerly financed by banks and credit agencies.
LLC Minuses
With multiple advantages to it, an LLC structure still has a few minor drawbacks.
Lower Fund-Raising Opportunities
Limited liability companies are less attractive to independent investors than corporations due to taxation fuss. This limits their funding options to a certain extent.
However, choosing a corporate tax status can resolve this problem and offer more understandable taxation routes to investors.
Limited Ownership Transfer
Since LLCs don’t issue stock, membership transfer is not an easy task. Some states even call for the company’s dissolution in case of changes in ownership structure. Yet, you can avoid this risk by outlining the business dissolution conditions in the Operating Agreement.
Annual LLC Tax
Some jurisdictions impose a franchise tax on companies, which is actually the payment to the state for the benefit of using an LLC structure. These are such states as:
- California;
- New York;
- Texas;
- Maryland, etc.
That tax rate might appear quite high, especially for startuppers and small firms, and noticeably increase your running costs.
Types of LLCs
Though all companies bring the same benefits related to their legal structure, there are several common LLC types that best match different business situations.
Domestic LLCs
These are limited liability companies operating in the same state where they are registered. This is the type that is normally mentioned when talking about LLCs since this legal structure is meant to maintain local business and relies on local laws.
Foreign LLCs
First off, this term has nothing to do with businesses run beyond the US. In relation to LLCs, it refers to businesses conducted in another US state different from the home state where an entity is formed.
If you plan to expand or move your business outside the formation domicile, you’ll have to establish a foreign LLC in that state by filing a foreign qualification there.
Professional LLC
This type of company is created to provide some sort of professional service. A PLLC structure will best suit your needs if you plan to do the following:
- Run a law practice;
- Open an accounting firm;
- Deliver engineering or construction service;
- Open a clinic, etc.
To establish a PLLC, its owner should have an appropriate professional license in place that verifies the corresponding qualifications. With that, some states have a requirement for licensed professionals to form PLLCs to legalize their business.
One more detail to mention here is that PLLC protections don’t cover professional malpractice. Should any accidents appear that are caused by professional negligence or mistakes, a license holder will be kept liable for them.
Series LLC
It’s a specific legal structure allowing different series of businesses under the umbrella of a single parent company. Existing as separate entities, those affiliates will make use of the parent LLC liability shield and will be protected against the liabilities of each other.
As such, a series limited liability company is a great choice for businesses generating profits from different sources. It’s worth noting, though, that series LLCs are allowed only in 17 states out of 50.
How to Register an LLC?
Unlike corporations governed by federal law, LLCs are formed under and regulated by state laws. Though very much alike across the US in general, those laws could slightly vary by jurisdiction.
Most often, the differences occur in the formation, filing, reporting, and taxation requirements. That’s why it’s recommended that you check local regulations in the state you are going to form your company.
At the same time, basically, the registration procedure is pretty much the same throughout the state and embraces only a few steps:
- Pick a name for your future company and make sure it’s available in the state of formation;
- Find and appoint a registered agent which is a law requirement in all 50 states;
- Prepare and file the Articles of Organization with the Secretary of State;
- Draft and sign an Operating Agreement (this step is optional in most states, yet highly recommendable);
- Acquire an Employer Identification Number (EIN) from the IRS.
