What does LLC mean, and is it right for your business?

Starting a new business and don't know which official company structure is best? Perhaps you've heard of a limited liability company (LLC), sole proprietorship or an S corporation or C corporation. For now, let's focus on LLCs.

What does LLC mean? This business legal entity is a hybrid between a corporation and a partnership. LLCs have some tax benefits as well as ownership advantages for businesses.

What is an LLC?

An LLC is a business structure that, as its name implies, provides added legal protection against personal liability. It provides the benefits of a corporation while protecting your personal properties and assets, like your house or savings. That means the business owners and shareholders are not held personally liable for any business losses or risks. An LLC isn't the only business entity that offers this limited-liability protection — corporations do, too.

Different states have different regulations defining LLCs. Most states don't restrict ownership, so owners, also known as members, can be individuals, corporations, other LLCs or foreign entities. There is no maximum number of members, and most states allow single-member LLCs, which have only one owner. Nearly any type of business can be an LLC, except for banks and insurance companies.

Tax advantages of an LLC

Protecting personal assets isn't the only benefit of filing as an LLC. There are tax advantages, too.

LLCs, like S corporations, are taxed on a "pass-through" basis, which means all profits and losses from the business pass through each member's personal tax return. However, the LLC has more flexible taxation options. LLCs can opt to be taxed by the IRS as a sole proprietorship or as a corporation. Different members can have profits allocated differently. Moreover, LLCs are not required to pay Social Security or Medicare taxes on their profits.

How do you start an LLC?

Laws and processes vary from state to state, so make sure you understand them before you register your business. These are some of the common steps you'll need to go through:

1. Determine an official business name

Check your state's naming requirements before you get started, and do a name search on the state's website for business filings to see which names are taken. Most states won't allow you to choose a business name that's already in use. Most states also don't allow the use of words that suggest you're in banking or insurance, which are forbidden from operating as an LLC.

2. Decide who will be the registered agent

If it's a single-person company, you might think it's a no-brainer that you'd choose yourself. However, keep in mind that being the registered agent means your name and address become public record. Registered agents also need to be able to handle legal documents.

3. Formally organize the company

Each state has an agency that handles business filings. They may require articles of organization, a certificate of formation or another form that requests details such as your company name, address, business purpose, how the LLC will be managed and contact information. You'll also likely need to pay a filing fee.

4. Consider creating an LLC operating agreement

Not all states require LLCs to have an operating agreement, but it's an essential practice for all companies, especially if you have more than one owner. An operating agreement ensures everyone understands their responsibilities by detailing all the financial, legal and management rights.

5. Keep up to date on necessary paperwork

This is the way you keep your LLC active. The requirements vary by state but typically include filing an annual report and paying an annual fee.

Pros and cons of an LLC

Before you decide on an LLC, know what you're getting into. LLCs have advantages and drawbacks compared to other business structures.

LLC advantages

• Owners aren't personally liable for a business's debt and liabilities.
• Pass-through taxation means profits and losses pass through to individuals for taxes, avoiding double taxation.
• LLCs can opt to be taxed as a sole proprietorship or as a corporation.
• LLCs are easy to form and have less paperwork compared to corporations.

LLC drawbacks

• Regulations and compliance requirements vary from state to state, which can add complexity.
• Owners can be responsible for self-employment tax on their share of profits.
• An LLC structure might be less attractive to investors who are more comfortable with corporate structures, which provide more transparency and potential stock issuance.
• Bringing in new investors or changes in membership is more complex for an LLC than a corporation.

Differences between LLCs, partnerships and corporations

There's no one right choice for businesses when deciding on business structure. What's most suitable depends on the type, size and goals of the business. Here's a rundown of some of the main differences.

• Liability. Both corporations and LLCs offer limited liability, which protects the owners' personal assets. Partnerships can limit liability through what's called a limited liability partnership or LLP.
• Number of members. Both C corporations and LLCs can have unlimited shareholders. By contrast, S corporations are capped at 100.
• Taxes. LLCs, partnerships and S corporations are taxed on a pass-through basis, meaning the business profits and losses pass through to the owners. C corporations are taxed at the corporate rate and face the possibility of double taxation, which means that the profits are taxed at corporate and personal income rates.
• Stock issuance. Only corporations can issue shares of stock. Partnerships and LLCs can't, but they can sell stakes in the ownership.
• Shareholders and boards. Corporations are generally required to hold annual shareholder meetings and have a board of directors. LLCs and partnerships are not, and they don't have a board.

Are you interested in running your own LLC or other type of business? Read more about how Citizens can help.