The LLC or Limited Liability Company is the newest form of business incorporation, and is often described as a combination of a corporation and a partnership. Over 80% of small businesses are LLCs, and for many good reasons. With less requirements and more flexible ownership options than the other entities, LLCs provide business owners with limited liability protection. This means that the company assets are typically owned by the LLC and are separate from the personal assets from that of the LLC owner(s).

One of the most advantageous aspects of the LLC is that it has the ability to choose how it is treated as a taxable entity. According to the IRS an LLC is, by default, federally taxed as a partnership (in the case of a multi-member LLC) or as a sole proprietor (in the case of a single member LLC). The LLC, however, may elect to be taxed as a C or S corporation at any time the members so choose. This can be useful if the income from your business tends to fluctuate.

LLCs are also flexible with regard to how the owners are paid. For an LLC, if the members choose, the net income/profits of the LLC may be allocated to the members in different proportions to their ownership percentage in the LLC. This is different from a corporation, as corporations are required to distribute profits exactly in accordance with the proportion/percentage of ownership of each shareholder.

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What Does “LLC” Stand For?

The abbreviation "LLC" stands for limited liability company. The name refers to one of the primary benefits of this business entity type—LLCs allow business owners to keep their personal assets separate from those of the company. This effectively limits their own liability when it comes to company debts and responsibilities.

What is an LLC?

In the United States, a limited liability company is a business entity type that combines the pass-through taxation of a partnership or sole proprietorship with the limited liability of a corporation, creating the best of both worlds for business owners. LLCs have rapidly become one of the most popular business structures for new and small businesses, largely because they are considered to be simpler and more flexible than a corporation.

When you form an LLC, your business becomes its own legal entity, with separate debts and legal matters. However, LLCs are still tied to your personal taxes.

What Types of Businesses Should Choose an LLC?

If you don't plan on raising investment money for your business, think you might need asset protection and need flexible business management and taxes, then an LLC is likely the best choice for your business. Whether you are a sole proprietor, have a partner, or a multi-member corporation, the LLC is a great choice for small business owners, as it can provide the same limited liability protection as a corporation, without many of the complexities and formalities associated with them. At Incfile we see all sizes and verticals of businesses forming an LLC — from LLCs for real estate agents or financial advisors to solopreneurs such as personal trainers or even marijuana businesses. A number of entrepreneurs decide that an LLC is the business structure that fits their needs.

Some businesses are prevented from forming an LLC, however. Typically financial companies such as banks, financial trust companies and insurance agencies can't file as an LLC. LLCs are sometimes limited for industries in certain states, too. For example, if you live in California, you can't form an LLC if you're an architect, accountant or licensed health care provider. Check out our LLC information by state for more details on your state.

The Advantages & Disadvantages of LLCs

The LLC structure has many benefits that make it perfect for a wide variety of companies. However, there are also some disadvantages to creating an LLC. Here are some of the biggest pros and cons to keep in mind.

Benefits of Starting an LLC

Limited Liability Protection By forming an LLC, only the LLC is liable for the debts and liabilities incurred by the business — not the members. The members liability is limited to the personal interest they have invested in the company thus protecting the personal assets of the individual member that are separate from the LLC.
Pass Through Taxation The LLC typically does not pay taxes for itself. Instead, the net income/loss is "passed through" to the personal income of the owner(s)/member(s), and is simply taxed as personal income. Federally, LLC taxation is handled very much the same as a partnership or sole proprietorship, in the case of a single member LLC.
No Ownership Restrictions The LLC does not have any residency or citizenship restrictions, which allows foreign nationals to have ownership in an LLC, if desired. In addition, other corporate entities may be LLC members which means that other corporations or LLCs (or other entities) may be a member of the LLC, or may be the sole member (although an LLC with a sole member that is a corporation or LLC is treated for tax purposes as a partnership or multi-member LLC).
Versatile Tax Status One of the most advantageous aspects of the LLC is that it has the ability to choose how it is treated as a taxable entity. According to the IRS an LLC is, by default, federally taxed as a partnership (in the case of a multi-member LLC) or as a sole proprietor (in the case of a single member LLC). The LLC, however, may elect to be taxed as a C- or S-corporation at any time the members so choose.

Flexible Profit Distribution For an LLC, if the members choose, the net income/profits of the LLC may be allocated to the members in different proportions to their ownership percentage in the LLC. This is different from a corporation, as corporations are required to distribute profits exactly accordance with the proportion/percentage of ownership of each shareholder.
Minimal Compliance Requirements LLCs are subject to limited state mandated annual filing requirements and ongoing formalities. While corporations are typically required to have at least an annual meeting of directors and shareholders (and initial meeting of the same), adopt bylaws, and keep minutes of all meetings and all formal corporate resolutions, an LLC is not required to do any of those things (see the explanation of an operating agreement, above). The LLC members may have whatever meetings they wish and may document any such things as they wish, however they are not required to do so.

Disadvantages of LLCs

Self Employment Taxes Although we listed Pass Through Taxation as an LLC benefit, it can also be a disadvantage. Oftentimes the taxes that are passed through and reported as personal income of LLC members will be higher than the taxes at a corporate level. You will also still pay for federal inclusions such as Medicare and Social Security. If you're confused if this business structure will be the right tax choice for you, it's a good idea to speak to your accountant or financial advisor.
Careful Personal Records As the owner of an LLC, you need to keep careful records of your business expenses — separate from your personal finances. This is the only way to ensure limited liability. Therefore, you should have separate bank accounts and cards to track business expenses.

LLC Termination Usually, if a member departs an LLC, then the LLC is terminated and ceases to exist. This is unlike a corporation where it still exists regardless of what shareholders come and go.
Banking Since it's required to keep your business finances separate from your personal finances, you'll need a business checking account. Banks usually charge a number of different fees and monthly expenses for these types of accounts. Also, If a check is made out to your LLC, then it is required to be deposited into a business bank account and cannot just be cashed. And some banks might charge extra for this type of deposit.
 

Understanding LLC Requirements
LLCs, unlike corporations, are not required to hold annual meetings and keep minutes, nor are they subject to the more stringent record keeping required of corporations. But there are certain LLC requirements you'll need to keep in mind.

LLC Operating Agreements
The governing document of the LLC is called an operating agreement, and it is within this document that the members lay out all important provisions, such as standards for LLC governance, ownership parameters, and rules around member changes (adding or removing members, or what happens in case of death or incapacity of a member). The operating agreement is an internal document and is an agreement amongst the members or owners, which means it is not recorded with the state.

LLC Annual Reports
In many states, LLCs must file an annual or biennial report with their Secretary of State. Failing to file can result in your business being dissolved. To learn more about annual reports (or to have Incfile file yours for you), click here, or view our LLC state guides to learn about specific requirements for your state.