This corporate structure personally protects owners from company liabilities.

What Is a Limited Liability Company (LLC)?

A limited liability company (LLC) is a business structure in the U.S. that protects its owners from personal responsibility for its debts or liabilities. Limited liability companies are hybrid entities that combine the characteristics of a corporation with those of a partnership or sole proprietorship.

While the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members of an LLC is a feature of a partnership rather than an LLC.

Understanding a Limited Liability Company (LLC)

Limited liability companies are permitted under state statutes, and the regulations governing them vary from state to state. LLC owners are generally called members.

Many states don’t restrict ownership, meaning anyone can be a member including individuals, corporations, foreigners, foreign entities, and even other LLCs. Some entities, though, cannot form LLCs, including banks and insurance companies.1

An LLC is a formal business arrangement that requires articles of organization to be filed with the state. An LLC is easier to set up than a corporation and provides more flexibility and protection for its investors.

LLCs may elect not to pay federal taxes directly. Instead, their profits and losses are reported on the personal tax returns of the owners. The LLC may choose a different classification, such as a corporation.2 If fraud is detected or if a company fails to meet its legal and reporting requirements, creditors may be able to go after the members.

Forming an LLC

Although the requirements for LLCs vary by state, there are generally some commonalities. The very first thing owners or members must do is to choose a name.

Articles of organization can then be documented and filed with the state. These articles establish the rights, powers, duties, liabilities, and other obligations of each member of the LLC. Other information included in the documents includes the names and addresses of the LLC’s members, the name of the LLC’s registered agent, and the business’ statement of purpose.

The articles of organization are filed, along with a fee paid directly to the state. Paperwork and additional fees must also be submitted at the federal level to obtain an employer identification number (EIN).

Advantages and Disadvantages of LLCs

The primary reason business owners opt to register their businesses as LLCs is to limit the personal liability of themselves and their partners or investors. Many view an LLC as a blend of a partnership, which is a straightforward business agreement between two or more owners, and a corporation, which has certain liability protections.

Although LLCs have some attractive features, they also have several disadvantages. Depending on state law, an LLC may have to be dissolved upon the death or bankruptcy of a member. A corporation can exist in perpetuity.

LLC vs. Partnership

The primary difference between a partnership and an LLC is that an LLC separates the business assets of the company from the personal assets of the owners, insulating the owners from the LLC’s debts and liabilities.

Both LLCs and partnerships are allowed to pass through their profits, along with the responsibility for paying the taxes on them, to their owners.2 Their losses can be used to offset other income but only up to the amount invested. If the LLC has organized as a partnership, it must file Form 1065. (If members have elected to be treated as a corporation, Form 1120 is filed).5

In an LLC, a business continuation agreement can be used to ensure the smooth transfer of interests when one of the owners leaves or dies. Without such an agreement in place, the remaining partners must dissolve the LLC and create a new one.

What Is a Limited Liability Company?