What is an LLC?
Find out what an LLC is and learn why so many businesses choose to structure themselves that way.
A Limited Liability Company (LLC) is a type of business structure that creates a legal separation between the business and its owner, or owners. As a result, those owners (also called members) may not be personally liable for the debts of the business.
An LLC can be taxed like a sole proprietor or a corporation and in some cases you can change how you’re taxed as your LLC grows.
Learn about other common small business structures
Pros of an LLC
Personal asset protection
As the name “limited liability” suggests, owners (or members) may not be personally accountable for all the acts or debts of the business. This can help protect their personal assets, like homes and savings, if the business fails. But make special note of the word “limited”. This structure doesn’t magically protect its owners from everything. An LLC owner may still be pursued through the courts for acts of negligence, for example.
An LLC can be taxed as a sole proprietor, a partnership, an S corporation or a C corporation. A tax advisor can tell you which approach offers the best outcomes. Your preference may change as you grow.
Freedom to choose equity partners and profit distribution
An LLC can have as many owners (called members) as it likes, and those members can be people or other businesses. LLCs often have some flexibility in deciding how income is allocated between owners.
Things you should know about being an LLC
Increased paperwork and admin
You need to submit paperwork to establish an LLC and there are lots of legal details to get right so you may need to hire an attorney or a legal service like LegalZoom. In some states, you’ll be required to submit an annual report. An LLC that expands to other states needs to register in each of those states.
Extra costs (direct and indirect)
It can cost hundreds of dollars to form an LLC and there may be ongoing annual costs. For example some states require you to pay “franchise tax fees” which, in case you’re wondering, aren’t just taxes for franchises. They can apply to any LLC or corporation. It’s a good idea to have legal support when forming an LLC, so factor in professional fees too.
Your personal tax situation may be more complex
Unless you elect to have your LLC taxed as a C Corporation, information and income (or loss) from the business will flow into your personal tax return. This happens even if the LLC files its own return. You may also have to pay self-employment taxes on your LLC income. Make sure you understand all the tax rules that apply to you, and complete all the needed schedules and forms. A lot of LLC owners use a tax professional to help.
How to start an LLC
Setting up an LLC can be complicated and it’s important to nail all the legal details. For that reason, most people like to have legal support through these steps.
- Choose a home state for your LLC – It’s common to form the LLC in the state where you plan to do the most business.
- Choose a name – Your LLC needs a name not already taken. Each state should have a website where you can search to see what’s available.
- Designate a registered agent – LLCs must have a registered agent who can receive official or legal documents on the company’s behalf. They can be an owner (member), an employee, or you can use a registered agent service.
- Prepare and file an LLC Articles of Organization form – You’ll need to submit paperwork that identifies the business and the way it will be managed. This is typically filed with the secretary of state in the home state of the LLC. Check your state’s requirements as this information may need to be published in a newspaper as well.
- Get an Employer Identification Number (EIN) – An EIN is required to open a business bank account and, as the name suggests, for hiring employees. You can get an EIN quickly and easily from the IRS website.
- Create an operating agreement – LLCs that will operate as a partnership benefit from having an operating agreement which lays out the rights of each member. It will explain things like how profits and losses will be distributed between them, how they can leave the LLC, and who is putting in the capital.
- Open a business bank account – Opening a business bank account helps to separate personal and business finances, plus it allows the business to build a credit rating.
- Register to do business in other states (if necessary) – You’ll need to register as a “foreign” LLC in each additional state you plan to do business in. You may also need a tax identification number for each state, and to register with the state’s labor department.
Make sure you understand the ongoing obligations of running an LLC in your state as there may be recurring reporting requirements.
Frequently asked questions about LLCs
People who ask “what is an LLC” also ask these questions.
Do I need an LLC for my business?
That depends on the nature of your business and its specific needs. If you’re a freelancer or solopreneur, managing with a simple sole proprietorship may be sufficient. On the other hand, LLCs offer lots of advantages such as protecting the individual from legal and financial difficulties the business may encounter, and providing options for methods of taxation. Be sure to do your research and seek professional legal and tax advice before making any decisions about forming any sort of legal entity.
How long does it take to get an LLC?
If you file online, it may be possible to get your LLC filed in a few days. LLC paperwork submitted by mail can take weeks to process.
Do I need a registered agent for an LLC?
Every state requires LLCs to have a registered agent who receives official or legal documents (such as subpoenas) on the LLC’s behalf. Anyone over 18 years old can be a registered agent, and you can name yourself or any employee but the agent must be available at an address in your state during normal business hours.
Who can form an LLC?
There are no residency or legal restrictions as to who can start an LLC. Some states impose requirements that members and/or managers must be at least 18 years of age or the age of consent. For more information regarding the requirements of each state, check the formation requirement website page for your state. In most states, you would register for an LLC with your state’s Department of Corporations or Division of Corporations. Please check your state government’s main website for contact information.
How is an LLC managed?
An LLC can either be managed by its members (owners) or by selected managers. Alternatively, they can hire managers and give them the authority to handle day to day decisions. It may be worth considering hiring managers if there are lots of members in the business.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
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