It is a good feeling to think of being a boss and opening up a business. However, once you have created a business plan and set your objectives the next important thing to do is how to organize your firm. The structure you select influences all of these factors: your taxes and paperwork, your personal liability and potential funds in the future.

Limited Liability Company (LLC) is one of the most flexible and most popular types of business in the U.S. Starting a small retail store or creating a tech startup, it is important to learn how an LLC works and make a decision whether it can be a perfect solution to you.

In this guide, we shall discuss what an LLC is, the comparison between an LLC and corporations and partnerships and the best pros and cons. We will also provide real life examples and some legal and tax fundamentals so that you are well prepared before going to establish your own LLC.

What is the Meaning of LLC?

LLC is the abbreviation of Limited Liability Company. It is a mixed business organization and it has characteristics of both the corporations and partnerships (or sole proprietorships). The most important characteristic of it is that it gives its owners or otherwise known as members limited liability protection but at the same time gives them pass-through taxation just like sole proprietorships or partnerships.

The LLC is considered as an entity that is separate with its owners. This implies that the business itself may own assets, run debts and enter into contracts: most legal actions will not be able to reach the personal property of the owners and most business losses will not affect their personal property.

History of the LLC in a Nutshell

The LLC is still a rather recent entity in the U.S., unlike corporations and partnerships. Wyoming passed the first formal law on LLC in 1977 based on German and Panamanian business models. First, LLCs were originally treated as corporations by the IRS and this was not so desirable.

Nevertheless, IRS permitted LLCs to be taxed as partnerships in 1988, and they achieved full potential. This transformation resulted in popular use. Currently, LLC is legally established in all the 50 states and it has become the favorite of entrepreneurs due to its flexibility and protection.

The important features of an LLC

Before we begin to discuss the advantages and disadvantages, it would be good to learn some of the basic characteristics that characterize the operation of LLCs:

• The owners are referred to as members – An LLC may possess one or more members.
• Limited liability Members are normally not personally liable to the business debts.
• Pass-through taxation – The profits and losses are passed to individual income of the members.
• State-specific regulations – the laws of LLC are somewhat different in different states.
• There is no limit to the number of members allowed in the organization- Both individuals and corporations can be members as well as foreign nationals.
• Management flexibility- The members have the choice of managing the LLC directly or employ managers.

The Best 10 Benefits of LLCs

Let’s check out the benefits of LLC organizations.

Limited Liability Protection

This is possibly the greatest advantage of an LLC. The personal assets of the members, such as houses, bank accounts, or cars, cannot be used to make a lawsuit or to cover business debts.

Example: In case a shoe store LLC has a debt of unpaid rent and invoices amounting to 75,000, the creditors will not be able to seize the personal savings and homes of the owner but only the business assets.

This protection may however be lost when the member commingles personal and business funds, when a member is guilty of fraud or when a member personally guarantees a loan.

Pass-Through Taxation

LLCs are pass-through entities by default, which implies that the business does not pay taxes on its own. Rather, the profits and losses are reflected in the individual tax form of each member. This prevents the double taxation, which happens to the corporations.

LLCs may also elect to be taxed as S corporations or C corporations by submitting IRS Form 8832. This flexibility enables the owners of the businesses to choose the structure that incurs the least taxations.

Cheap to Construct and Run

In comparison with corporations, LLCs are less expensive and simpler to establish. Every state has a filing fee on the formation document (which is typically referred to as the Articles of Organization), and although this fee varies, it is generally affordable by the startups.

An operating agreement is not mandatory in most states, but it is highly advisable, particularly in the case of LLCs with multiple members, to avoid confusion, as well as roles and profit distribution.

Facility of Formation and Operation

LLCs do not need complex formation such as board of directors or annual shareholders meetings. There are few paperwork, and recordkeeping is easy.

The process of forming an LLC typically requires:

• Submission of Articles of Organization with your Secretary of State
• Filing a fee that is specific to a state
• Preparing an Operating Agreement (particularly in the case of multi-member LLCs)
• Acquisition of pertinent licenses and permits
• Other states such as New York, Nebraska and Arizona also stipulate that the formation should be published in the local newspapers.

Management Flexibility

LLCs give much freedom in their management. You may opt to have a member-managed model (the business is run by the owners), or a manager-managed structure (the business is run by a manager appointed by the owners).

This is perfect in terms of active entrepreneurs and passive investors. In most states, corporate formalities such as annual reports, boards and meeting minutes are not required.

Credibility and Professionalism

Incorporation of LLC is an indication that your business is serious and professional that can be useful in:

• Trust building with the client
• Development of vendor relationships
• Business credit or loan application
• A one-person LLC gives an extra veneer of legitimacy that a sole proprietorship does not have.Flexibility of Profit Sharing

In contrast to corporations where profit is divided according to the share ownership, LLCs enable the members to divide profits as they wish.

As an example, a member can be entitled to 25 percent but get 50 percent of the profits in case of more effort or risk. It can be described in the Operating Agreement.

Ownership Structure Run Your Show

LLCs accommodate one-member businesses, which lets the business owner have total control, without the hassle of partnerships or the strict regulations of corporations.

Meanwhile, multi-member LLCs will be able to distribute duties using formal agreements, which will make everyone on the same page.

Protection of Charging Order

In most states, where one of the members of LLC has personal creditor, the creditor cannot cause the LLC to wind down assets. They cannot get a share of distributions instead, they are only entitled to the share of the debtor.

Access to 20 percent Pass-Through Tax Deduction

Due to Tax Cuts and Jobs Act, the owners of LLCs can exclude as much as 20 percent of qualified business income as a tax deduction. This advantage also lowers the amount of tax paid by LLC members who declare their incomes in their individual returns.

Examples of LLC in the Real World

Small businesses do not have exclusive rights on the use of LLCs; numerous popular and successful corporations have this form of organization. These are just some well known examples of how malleable and popular the LLC model can be:

Patagonia, LLC

Patagonia is a global outdoor apparel and equipment company that has a reputation of being a sustainable brand and environmental activist. Being an LLC, Patagonia has an advantage of flexible management structure, as well as shielding its owners against personal liability. Being an LLC gives the company an opportunity to achieve certain distinct objectives such as giving 1 percent of sales to environmental causes without compromising on the efficiency of the business.

Warby Parker, LLC

Warby Parker is one of the most successful eyewear retailers that began as a direct-to-consumer brand and has a powerful social purpose – with each pair of glasses sold, another one is donated to a person in need. Their LLC form provides them with the flexibility to expand rapidly and leaves its founders personally insulated against any legal or financial problem that the business may be under.

Chrysler (now FCA US LLC)

One of the most spectacular ones is the following: FCA US LLC is a large American automaker and it is a subsidiary of Stellantis (a multinational automotive conglomerate). However, although it is a huge company in all other aspects, FCA is legally an LLC in the United States. This demonstrates that even huge businesses can profit by using the LLC system when it is consistent with their legal and tax planning plans.

LLC vs. Other Business Structures

In a brief comparison, we are going to compare LLCs with two of the most common alternatives, corporations and partnerships.

Corporations tend to be at an advantage in the attraction of venture capital but LLCs are more flexible in management and taxation of smaller operations.

Feature	LLC	Corporation
Ownership	Members	Shareholders
Management	Member-managed or manager-managed	Board of directors & officers
Taxation	Pass-through or elect corporate taxation	Double taxation (C Corp) or pass-through (S Corp)
Formality	Fewer formalities	Must hold annual meetings, keep minutes, etc.
Investor Appeal	Limited	Preferred for outside investment

Corporations can be more favorable in attracting venture capital, however LLCs will be more flexible in management and taxation of smaller companies.

LLC vs. Partnership

Partnerships are easy to form, but they do not entail liability protection, which is risky.

 

Feature	LLC	Partnership
Liability Protection	Yes	No
Legal Entity	Separate from owners	Not separate
Taxation	Pass-through or corporate election	Pass-through only
Structure	Flexible	Less flexible

 

Top 10 LLCs disadvantages

These are the pitfalls of having an LLC.

The Limited Liability Does Not Apply Absolutely

When an owner intermingles personal and business finances, is fraudulent or negligent, the courts can subject them to personal liability by piercing the corporate veil.

It is necessary to keep the personal and the business assets separate to maintain protection.

Self-Employment Taxes

The members of LLC are automatically self-employed and are required to pay Social Security and Medicare on their portion of profits. This is usually more than the tax that a corporation pays.

To minimize this, certain LLCs choose to be taxed as S Corporations, where members receive salaries (subject to payroll tax) and the extra profits are received as distributions.

Greater Fees as compared to Sole Proprietorships or Partnerships

LLCs normally have a higher initial fee and annual fee as compared to the simpler structures. These can be:

• State filing charges
• Fees on annual report
• Franchise taxes

These costs can accumulate in very small or side businesses although it is still lower than corporations.

Challenge in Ownership Transfership

In comparison to corporations, where it is quite free to sell or transfer shares, membership changes in LLC frequently need the consent of the other members and can necessitate alterations in the operating agreement.

This reduces the flexibility of LLCs to do succession planning or attract investors.

Mixed up Roles and Responsibilities

In contrast to the corporations that have specific positions (directors, officers, shareholders), LLCs can become a source of confusion concerning authority distribution, in particular, in the cases when the Operating Agreement is not clear.

Such uncertainty may delay decision-making or lead to in-house conflicts.

Short Life Span

A member of an LLC can dissolve the LLC in some states when a member dies, resigns or becomes bankrupt unless the Operating Agreement stipulates continuity. However, corporations are immortal.

Less appealing to Venture Capitalists

The majority of venture capital firms favor corporations, particularly C Corps, because of easier stock issuing and more transparent governance. A corporation may be a better option in case you intend to attract large investments.

Variability of State Law

The rules of LLC differ considerably across states, including the requirements to file and report. A structure which is beneficial in one state might be more costly in the other.

Additional Compliance in Certain States

Such states as California impose high minimum franchise taxes on LLCs, as high as 800 dollars a year, even when they make no profits. Administrative overhead can also be caused by publishing requirements in other states.

Comprehensiveness of Tax Classification

Although flexibility in tax is a merit, it makes it complex. You will be required to select the taxation status of your LLC (a sole proprietor, partnership, S Corp, or C Corp). You may also be required to file form 8832 or form 2553 with the IRS.

Final Thoughts

The creation of an LLC provides a good median between sole proprietorships and corporations. It affords you limited liability protection, possible tax benefits and flexible management alternatives and does not have the complexity and formality of a full corporation. Nevertheless, LLCs, as well as any other type of business organization, are not a universal solution. You will have to consider such aspects as the peculiarities of the rules in your state, the further financial strategy, and the way you would like to deal with taxes.

An LLC is commonly the correct decision when it comes to small to medium sized businesses whose primary objectives are personal asset protection, spending less money on the start-up costs, and the ability to be in charge of the daily processes.

Still unsure? The Finance Focus will assist you with that, whether it is assessing your choices or registering your LLC and ensuring that you remain compliant, we will simplify the process and make it stress-free.