Limited Liability Companies Explained: Pros and Cons of LLCs

In the United States, a limited liability company (LLC) is a private company that offers personal liability protection to its owners. It is possible to form both a single-member LLC (one owner) and a multi-member LLC (multiple owners). Forming an LLC requires planning and adherence to state law. The limited liability company you form will be a legal entity with its own registered business name, bank account, articles of organization, and operating agreement.

In many states, the LLC is responsible for an annual franchise tax, but it does not pay federal tax on its annual income. Rather, an LLC functions via pass-through taxation, where the profits and losses of the business are reflected on the business owners' personal tax returns. This shields the owners of an LLC from double taxation, a situation where both the company and its owners owe taxes. LLC members also avoid personal liability for the business’s misdeeds. For example, if someone sues an LLC for financial damages, the personal assets of the LLC’s owners are not at risk. Similarly, owners are not held liable for business debts the LLC may incur.

To organize your business entity as an LLC, you must adhere to your specific state's business laws. Laws vary by state, but generally, you’ll take the following steps to form an LLC:

• Register with the state. The limited liability company must be registered with the state. In most states, the business files articles of organization with the secretary of state's office, and this requires a small filing fee. See your secretary of state's website for specific requirements.
• Write an LLC operating agreement. To govern an LLC, you need an operating agreement that specifies the number of members, ownership stake, and rules outlining basic operations. Generally, small business owners do not want their operating agreement to be overly prescriptive about day-to-day operations. Instead, write an operating agreement that gives your company space to grow and evolve without violating its own founding charter.
• Designate a registered agent. Your LLC will need a registered agent who can accept legal documents on behalf of the entity.
• Get an employer identification number (EIN). Companies use their EIN for tax purposes much in the same way individuals use their social security numbers. You will also use this EIN when filing LLC taxes with your state and the IRS. You can request an EIN when you file articles of the organization.
• Set up a bank account. The LLC will need its own bank account from which it can pay bills, accept payments, and submit federal or state taxes as applicable.
• Explore liability insurance. Most states do not require an LLC to carry liability insurance, but depending on your type of business, such insurance may be advised.

Forming an LLC can make sense for small business professionals who seek asset protection and wish to avoid double taxation on business income.

1. 1. Separation of finances: Forming an LLC lets you keep your business expenses separate from your personal expenses. It also allows you to take on debt for business purposes without threatening your personal bank account.
2. 2. Asset protection: An LLC protects your personal assets and account balances. It shields them from lawsuits related to business activities.
3. 3. Flexibility: Business partners have a number of ways to organize their business entity, from limited partnerships all the way to corporations. For most small business needs and business partners, an LLC may make the most sense because it combines the asset protection of a corporation with the relative simplicity of a limited liability partnership. You can form an LLC even if you are the sole proprietor of your business.
4. 4. No double taxation: An LLC does not pay income tax to the Internal Revenue Service. Its profits pass through to its members, who declare them on their personal income tax returns.
5. 5. Business loss tax advantage: An LLC can provide its members with a tax advantage if the company operates at a loss. If the company spends more money than it takes in during a given year, its members can claim an income loss on their personal income tax returns.

Although an LLC can fit many people's small business needs, it does come with some disadvantages.

1. 1. Difficult to take on investors: Business law does not allow an LLC to issue stock, and adding new members can be tedious and contentious. If you are running a business that must recruit investors (such as a real estate investment group), an LLC may not be right for you. Consider a limited partnership (LP) or, if you are running a larger firm, consider incorporating as a C-corporation and paying dividends to investors.
2. 2. Paperwork and fees: Limited liability companies are subject to paperwork and fees. An LLC does not need a board of directors like a corporation, but it does need a formal operating agreement. Most states also require LLCs to pay an annual fee—usually called a franchise tax—and regular statements of information.
3. 3. Difficult to partner with some businesses: If you seek to engage in joint business ventures with large corporations, you may be better off forming an S-corporation (S-corp). For example, if you own a film production company and would like to join up with a large studio, having an S-corp may make the process easier. Choosing between an LLC and an S-corp will require an assessment of how much you rely on outside partnerships to conduct business.

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