What Is a Limited Liability Company (LLC)?
A limited liability company (LLC) is a business structure in the U.S. that protects its owners from personal responsibility for its debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.
While the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members of an LLC is a feature of a partnership rather than an LLC.
- The limited liability company (LLC) is a corporate structure that protects its owners from being personally pursued for repayment of the company's debts or liabilities.
- Regulation of LLCs varies from state to state.
- Any entity or individual can be a member of an LLC with the notable exceptions of banks and insurance companies.
- LLCs do not pay taxes on their profits directly.
- Their profits and losses are passed through to members, who report them on their individual tax returns.
Understanding a Limited Liability Company (LLC)
Limited liability companies are permitted under state statutes, and the regulations governing them vary from state to state. LLC owners are generally called members.
Many states don't restrict ownership, meaning anyone can be a member including individuals, corporations, foreigners, foreign entities, and even other LLCs. Some entities, though, cannot form LLCs, including banks and insurance companies.
An LLC is a formal business arrangement that requires articles of organization to be filed with the state. An LLC is easier to set up than a corporation and provides more flexibility and protection for its investors.
LLCs may elect not to pay federal taxes directly. Instead, their profits and losses are reported on the personal tax returns of the owners. The LLC may choose a different classification, such as a corporation. If fraud is detected or if a company fails to meet its legal and reporting requirements, creditors may be able to go after the members.
The wages paid to members are deemed operating expenses and are deducted from the company's profits.
Forming an LLC
Although the requirements for LLCs vary by state, there are generally some commonalities. The very first thing owners or members must do is to choose a name.
Articles of organization can then be documented and filed with the state. These articles establish the rights, powers, duties, liabilities, and other obligations of each member of the LLC. Other information included in the documents includes the names and addresses of the LLC's members, the name of the LLC's registered agent, and the business' statement of purpose.
The articles of organization are filed, along with a fee paid directly to the state. Paperwork and additional fees must also be submitted at the federal level to obtain an employer identification number (EIN).
Advantages and Disadvantages of LLCs
The primary reason business owners opt to register their businesses as LLCs is to limit the personal liability of themselves and their partners or investors. Many view an LLC as a blend of a partnership, which is a straightforward business agreement between two or more owners, and a corporation, which has certain liability protections.
Although LLCs have some attractive features, they also have several disadvantages. Depending on state law, an LLC may have to be dissolved upon the death or bankruptcy of a member. A corporation can exist in perpetuity.
An LLC may not be a suitable option if the founder's ultimate objective is to launch a publicly traded company.
LLC vs. Partnership
The primary difference between a partnership and an LLC is that an LLC separates the business assets of the company from the personal assets of the owners, insulating the owners from the LLC's debts and liabilities.
Both LLCs and partnerships are allowed to pass through their profits, along with the responsibility for paying the taxes on them, to their owners. Their losses can be used to offset other income but only up to the amount invested. If the LLC has organized as a partnership, it must file Form 1065. (If members have elected to be treated as a corporation, Form 1120 is filed).
In an LLC, a business continuation agreement can be used to ensure the smooth transfer of interests when one of the owners leaves or dies. Without such an agreement in place, the remaining partners must dissolve the LLC and create a new one.
What Is a Limited Liability Company?
A limited liability company, commonly referred to as an “LLC”, is a type of business structure commonly used in the United States. LLCs can be seen as a hybrid structure that combines features of both a corporation and a partnership. Like a corporation, LLCs provide their owners with limited liability in the event the business fails. But like a partnership, LLCs “pass-through” their profits so that they are taxed as part of the owners’ personal income.
What Are Limited Liability Companies (LLCs) Used for?
The LLC has two main advantages:
- It prevents its owners from being held personally responsible for the debts of the company. If the company goes bankrupt or is sued, the personal assets of its owner-investors cannot be pursued.
- It allows all profits to be passed directly to those owners to be taxed as personal income. That avoids "double taxation" of both the company and its individual owners.
What Are Some Examples of LLCs?
LLCs are more common than many realize. Alphabet, the parent company of Google, is an LLC, as are PepsiCo Inc., Exxon Mobil Corp., and Johnson & Johnson.
There are many much smaller LLCs. There are variations that include sole proprietorship LLCs, family LLCs, and member-managed LLCs.
Many physicians' groups are registered as LLCs. This helps protect the individual doctors from personal liability for medical malpractice awards.
Are Limited Liability Companies Taxed Differently Than Corporations?
Yes. In the case of a corporation, profits are first taxed at the corporate level and then taxed a second time once those profits are distributed to the individual shareholders. This “double taxation” is decried by many businesses and investors.
Limited liability companies, on the other hand, allow the profits to be passed directly to the investors so that they are taxed only once, as part of the investors’ personal income.
The Bottom Line
Limited liability companies (LLCs) are important legal structures for forming a business. Limited liability means that the assets and debts of the business remain separate from the personal assets and debts of the company's owners. If a company goes bankrupt, creditors cannot therefore go after the owners' personal assets, just that of the business. LLCs also have several beneficial features including simplified taxation and a relatively straightforward process to establish one. This is part of the reason why LLCs are the most common type of business in the U.S.