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by Mike Vestil 

What Is An LLC (Limited Liability Company) And How Does It Work?

An LLC is a corporate structure that provides limited liability protection to its owners, much like a corporation. The owners are known as "members" instead of shareholders in an LLC. An LLC can be owned by one or more individuals, corporations, other LLCs, or any combination of these.

In this article, I'll share all the essential information about LLCs so you can decide if this is the proper structure for your business.

What Does LLC Mean?

LLC stands for Limited Liability Company. It is a business structure that provides limited liability protection to its owners, known as members, while still allowing the flexibility of pass-through taxation. LLCs are governed by state law; the governing document is usually known as an Operating Agreement. This agreement outlines the internal rules and regulations that govern how the LLC will be operated.

What Is The Purpose Of An LLC?

The purpose of an LLC (Limited Liability Company) is to protect its owners' personal assets. In the event of any debts or obligations of the business, the members of an LLC will not be held personally liable. An LLC also offers its members more flexibility than a corporation regarding how profits and losses are allocated.

How Does An LLC Work: Key Information When Forming An LLC

An LLC combines the features of both a corporation and a partnership. An LLC offers its members flexibility regarding how profits and losses are allocated.

Unlike a corporation, an LLC doesn't have a board of directors or shareholders responsible for decision-making. Instead, the members of the LLC (or their designated managers) make all business decisions and set the rules governing the company's operations. This flexibility is one of the main advantages that LLCs offer over corporations.

In terms of LLC taxes, LLCs can choose whether to be treated as a partnership, S corporation, or C corporation for federal income tax purposes. This allows the LLC to select the taxation structure that best suits its needs.

What Is The Typical LLC Structure?

The typical LLC structure comprises "Members" and "Managers." Members are owners of the LLC and are responsible for selecting the managers who will make decisions on behalf of the business. Managers can be members themselves, or they can be third-party individuals authorized to make decisions on behalf of the company.

An LLC allows its members to set rules governing how profits and losses are allocated and how to deal with potential conflicts. This flexibility gives LLCs an advantage over corporations which require a board of directors to approve all major decisions.

What Are The Pros And Cons Of An LLC?

Here are some of the pros and cons of the LLC business structure:

Pros

Limited Liability Protection

Protecting your assets is one of the main benefits of an LLC. Your personal assets are protected from potential creditors or debtors if your business fails.

Pass-Through Taxation

As a disregarded entity LLC, under the Internal Revenue Service (IRS), LLCs are treated as pass-through entities and taxed like a partnership. This means that members pay taxes on their individual returns according to their share of ownership in the company.

Flexible Management Structure

Unlike corporations, LLCs don't have a board of directors or shareholders responsible for decision-making. Instead, the members of the LLC (or their designated managers) make all business decisions and set the rules governing the company's operations. This allows businesses to be more flexible when setting up their organizational structure and operations.

When paying yourself from an LLC, you can determine how profits and losses are allocated, which is impossible for corporations.

Transferable Ownership

Ownership of an LLC can be transferred using a variety of methods. This allows LLCs to expand by adding new members as needed without going through a lengthy process.

Separate Business From Personal Assets

As an independent entity, the LLC structure helps protect your assets if your company gets into financial trouble or is sued by creditors or debtors. The "corporate veil" created by forming an LLC protects your assets from liability incurred by your business operations.

Cons

Now, let's look at some of the potential drawbacks of an LLC:

Cost And Complexity

Forming and maintaining an LLC typically requires more paperwork than other business structures, such as sole proprietorships or partnerships. This can result in additional costs for filing fees, attorney's fees, etc.

From getting the proper LLC license to filing taxes, there may be more paperwork than you realize.

Self-Employment Taxes For Members Of A Single-Member LLC

If you are the only member of an LLC, then you will be responsible for self-employment taxes in addition to regular income tax. This means that your net pay from the business may be significantly lower than it would be with other business structures since a large portion is going toward taxes.

As a single member LLC, you are also responsible for paying employer-equivalent taxes, such as Social Security and Medicare.

Lender Hesitation In Providing Loans Or Credit To LLCs

Due to their limited liability protection, lenders may be hesitant to give out loans or provide lines of credit to LLCs as they view them as more risky investments. However, loan officers can often help LLC owners obtain financing if needed.

Perception Of Diminished Credibility

As an unincorporated business structure, some people may perceive LLCs as less credible than corporations. This is partly because LLCs have fewer formalities and no board of directors. However, an LLC can be as credible if appropriately managed as any other business structure.

Additional Record-Keeping Requirements

Since LLCs are separate legal entities from their owners, they must keep accurate records of all financial transactions and maintain corporate minutes that document significant decisions made by the members. This may require additional effort from the owners, who must ensure all documents are filed correctly with their state or local government agencies. Additionally, failure to comply with these requirements could result in severe penalties such as fines or even dissolution of the company.

Limited Liability Company Examples

An LLC allows various businesses to operate with limited liability protection and the flexibility to make decisions about many of the key aspects of their business.

Some examples of LLC-suitable businesses include the following:

  • Restaurants: A restaurant can benefit from an LLC structure because of the liability protection it offers. This is especially true for restaurants in busy areas or with risky operations, such as deep fryers or stoves.
  • Rental Property: Owners of rental properties can form an LLC to protect their personal assets in case of a legal dispute over the property. In addition, forming an LLC allows owners to add additional members easily and easily transfer ownership.
  • Small Business: Many small businesses opt to form an LLC. From businesses dealing with complex regulations to those providing personal services, LLC owners can benefit from the protection it offers.
  • Consulting Firms: Consulting firms also benefit from the limited liability protection offered by an LLC structure, allowing them to focus on delivering quality services without worrying about potential legal issues. If a customer files a lawsuit against the firm, their personal assets are protected.

Why Do People Choose An LLC Over Other Business Structures? Key Differences To Consider

When choosing between an LLC and other business structures, many people find that the limited liability protection offered by an LLC is more attractive than what they would get with a sole proprietorship or partnership. 

Additionally, income taxation may be more straightforward for LLCs since members can choose either pass-through taxation or corporate taxation, depending on their individual needs. 

Finally, forming and maintaining an LLC requires less paperwork than other business structures, such as a corporation, making it easier to set up and manage your company. All these factors make forming an LLC appealing to entrepreneurs looking to protect their assets while running a successful business.

What Does An LLC Mean In Terms Of A Small Business That Is Already Running?

Forming an LLC can still provide many benefits if you have a small business already running.

For example, going from a sole proprietorship to an LLC can give you additional protection from personal liability, meaning any liabilities or debts your business incurs will not personally affect you.

Can I Use LLC For An Online Business?

Yes, you can use an LLC for an online business. Forming an LLC can provide both the limited liability protection and tax advantages that are important when starting any business. 

Many entrepreneurs who have created successful online businesses opted to form an LLC as it gives them the most flexibility regarding how they organize their operations.

Especially for online businesses dealing with customer data or selling digital products, forming an LLC is recommended as it offers additional protection against potential legal issues. 

An LLC is relatively simple, and with the help of online tools and resources, it is possible to set up an LLC for your online business quickly.

Is Closing An LLC Difficult?

Closing an LLC is usually fairly straightforward, though there are specific steps you must take to ensure the process goes smoothly. Depending on the state in which your LLC was organized, you may need to notify various state agencies and creditors. You will also need to settle all outstanding debts and liabilities, distribute remaining assets among owners or members, and file any necessary tax returns.

Additionally, if you don't properly close your LLC by filing the required paperwork with the state, it could stay active, and you may still be liable for any of its activities (including taxes). It is essential to consult with a lawyer or accountant before attempting to close an LLC to understand all the requirements for a successful dissolution.

What Is An LLC - FAQ

Should I Start An LLC In Texas?

Part of knowing how to start an LLC in Texas is understanding that it’s cheaper to set up this business structure than registering a limited partnership in this state.

It's also the same as setting up a corporation but with the advantage of having limited personal responsibility. Starting an LLC in Texas is relatively easy because the state has simplified its business requirements and fees.

Consider whether you'll be mainly doing business in Texas and whether you want to take advantage of its various tax benefits before deciding.

Ultimately, deciding whether or not to start an LLC in Texas will depend on your individual needs and goals for your business. It is essential to research all of your options before deciding so you make sure you're choosing the best structure for your online business.

Conclusion

An LLC is a popular business structure that provides owners with limited liability protection and flexibility in taxation. 

LLCs are suitable for any small business, including online businesses. Additionally, forming an LLC requires less paperwork than other structures, such as a corporation or partnership, and offers more control to members over their company's operations. 

Therefore, when considering different structures for your small business, it is essential to weigh the pros and cons of each option before deciding on one that best meets your needs.

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About the author 

Mike Vestil

Mike Vestil is an author, investor, and speaker known for building a business from zero to $1.5 million in 12 months while traveling the world.

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