Many new businesses are structured as limited liability companies (LLCs), which offer key advantages over other business entities. An LLC is a type of business that can be formed by one or more people (or entities). The owners each participate in the management of daily business operations and have limited liability for business debts and obligations.
An LLC blends certain positive attributes of a:
State laws governing LLCs might vary, but typically LLCs offer five main advantages for new businesses.
An LLC is viewed as a legal entity separate from its individual members or owners. Similar to shareholders of a corporation, an LLC owner is not personally liable for the LLC's debts or legal liabilities. For example, if your LLC has $5,000 in debt, the creditors probably can't come after you personally to recover the money.
The LLC owner can usually only lose their capital contribution to the business—like corporate shareholders. For example, suppose Hunter and Cody have an LLC together. Hunter invests $20,000 into the company, and Cody invests $30,000. The LLC struggles to take off and accumulates $70,000 in debt. The LLC can use the $20,000 Hunter invested and the $30,000 Cody contributed to partially pay off the business's debts. While Hunter and Cody will lose their investments, they won't need to use any of their own money to pay the remaining $20,000 in business debt.
An LLC's legal obligations usually don't put the LLC owner's personal assets, such as a home or individual bank account, at risk. Creditors can't come after your—or, if you're married, your spouse's—personal assets to pay the business debts.
For instance, if your business owed $10,000 to a creditor, the creditor could only sue the business, and not you personally, to recover the debt.
As with other business organizations, you could still be personally liable for business debts in some instances, such as when:
For more information, read about when you might be personally liable for LLC debt.
State laws usually apply equal management responsibilities and duties to LLC owners. But LLC members (or owners) are generally free to set their own rules for how the LLC is managed and operated.
You can spell out each member's role and responsibilities in an operating agreement. An operating agreement is the governing document for an LLC, and every LLC should have one—especially if you don't want to follow the default rules in your state's LLC laws.
You can specify which member handles or is in charge of the business's:
Entrepreneurs are self-starters who prefer to chart their own courses. Most states recognize a single-member LLC, which means that you can be the sole owner of your business. As a single-member LLC, you can make your own business decisions without having to consult with and receive approval from:
Like a sole proprietor, you own, manage, and operate your business, but without the same liability issues of a sole proprietor.
Because LLCs are not recognized entities for tax purposes, owners have to elect how they want their LLCs to be taxed. You can choose to have your LLC taxed as a:
There are advantages (and disadvantages) to each tax structure. Corporations typically have lower tax rates but you face double taxation. Both the business and the individual owners are taxed on the business's income. Alternatively, S corporations and partnerships are known as "pass-through" entities, and only the owners are taxed, not the business. (For more information on how corporations and LLCs are taxed, read our article on corporations and S corporations vs. LLCs.)
Single-Member LLCs are taxed as sole proprietors. If you're the only owner of your LLC, then you're considered a sole proprietor for tax purposes. You'll also be considered a pass-through entity.
Standard corporations typically face the burden of double-income taxation. The corporation's profits are taxed as income and shareholders must pay income taxes on any dividends. LLCs that don't elect corporation status receive "pass-through" treatment and avoid double taxation. Instead of taxing the business and its members, each member is only taxed on their share of the profits.
Unless you elect otherwise, the IRS treats LLCs as partnerships for tax purposes. So, you'll be able to immediately avoid double taxation. Instead, you'll report the business's profits and losses on your individual income tax return. If you elect S corporation status, you can also avoid double taxation. (For more information, read how LLC members are taxed.)
As an owner of a pass-through business entity, you might be able to take advantage of the 20% pass-through deduction established under the Tax Cuts and Jobs Act. Under this law, you'll only be taxed on only 80% of your business income.
For example, if you made $100,000, you'd only be taxed on $80,000. This deduction can save you a significant amount. Not only will your taxes be less, but you might also qualify for a lower tax bracket and lower tax rate.
Establishing and maintaining an LLC is less complex and requires less paperwork than other corporate entities.
An LLC registers its existence by filing articles of organization with and paying a fee to the relevant state office, normally the secretary of state.
You'll typically only need to provide the following basic information in your articles of organization:
Similarly, corporations must file articles of incorporation with their state's office. After filing, corporations must then hold an organizational meeting to:
The corporation's board of directors will meet regularly to discuss and finalize business strategies, finances, and policies and can call special meetings when emergency action is needed. Corporations are also required to hold an annual shareholders meeting. In addition, corporations typically must file annual reports and pay yearly fees to retain their corporate status.
In most states, these meeting and reporting requirements don't apply to LLCs. Instead, LLCs are usually only responsible for an annual fee and filing obligations.
In most cases, business entities distribute profits based on an owner's capital contribution (investment) or percentage of ownership interest. In a general partnership, partners normally share profits equally. Corporations can pay dividends based on each stockholder's proportion of ownership interest.
However, LLC members have the flexibility to determine how profits are distributed—and usually defined these terms in the LLC's operating agreement. LLC members aren't limited to their proportion of ownership. They can decide to divide up profits in a different way.
For example, one member might agree to take less than their proportional share in profits if another member agrees to put in extra hours and efforts toward the LLC's daily operations.
But LLCs have some limitations on how they can distribute profits. They can't allocate profits when:
Also, the IRS has rules that require allocations not based on ownership interest—called "special allocations"—to reflect a legitimate economic circumstance. The purpose of these rules is to prevent owners from merely trying to gain a tax advantage.
For more information, you can visit the Small Business Administration's website or contact your local division of corporations or secretary of state's office. If you have specific legal questions about how your business can capitalize on the benefits of LLCs, you should talk to a business attorney. They can help you take advantage of the tax deductions, explain your liability risk, and draft your operating agreement.