What is an LLC?

what is an llc

LLC stands for Limited Liability Company. Many business owners are drawn to forming an LLC because of that business entity’s most attractive feature: An LLC provides protection for the personal assets of owners and members.

Is an LLC the right choice for your business? Let’s explore the business structure – its pros and cons – so you can decide.

What is an LLC, and How does it Work?

With the limited liability company structure, there can be one owner, two owners (a partnership), or many members. Similarly, what is an LLC operating agreement?

There are choices in the management structure. All the members can have a role in management by having voting rights. The voting rights can be “weighted” or have more clout according to the percentage of ownership the member has in the company.

Memberships in an LLC are transferable. Members share in profit and losses; if it’s a partnership, the partners share in profit and losses.

The owners can choose whether or not to be taxed as a partnership or an S Corp, whichever will be more beneficial.

All these types of decisions are spelled out in two key documents: articles of organization and operating agreement. The articles of organization name who is who, and what their roles are. The operating agreement details the business structure, steps for transferring memberships, and how the LLC will be managed.

Should I Start an LLC?

There are two main reasons for forming a limited liability company LLC: 1. To protect the owners or members personal assets from liability if the business fails and 2. To realize tax advantages. For more information read reasons to start an LLC and what type of businesses should be one, for example, small business LLC.

What are the Benefits of having an LLC?

There are many benefits to forming a limited liability company, which also begs the question what can you do with an LLC? That doesn’t mean an LLC is the best choice for every business. There can be as many cons to match the pros – see Pros and Cons of an LLC.

Here is a list of the benefits:

Limited Liability Protection: Personal assets of owners and members protected.

Taxation Choices: Tax impacts can be passed through to owners or members as income on an individual’s tax return (pass-through taxation), or the LLC can be taxed as a C Corp or S Corp.

Transferability of Membership: This can be quite simple as spelled out in the operating agreement.

Management Flexibility: The LLC can have one manager who is a member of the LLC, or the LLC can hire a manager who is not a member. The LLC can be run by a committee.

Profit and Loss Pass-through: The LLC profit and loss can be passed through to individual members (pass-through taxation), and adjusted to reflect the percentage of ownership.

Members can have voting rights.

Silent Memberships: When the LLC is formed, the members don’t have to be listed on the documents.

Taxation: Forming an LLC can be a way to avoid double taxation. If a business is a corporation, the business itself may be taxed, and the owners may also be taxed on profits.

What are the Downsides to a Limited Liability Company?

One of the main downsides of forming an LLC is that the annual renewal fees can be high. The fees vary by state. Also, there are publication requirements – also vary by state – which must be met for the LLC to remain in operation.

To learn more read the Pros and Cons of an LLC.

There are additional downsides.

It may be difficult to raise capital when the LLC is being formed.

Although it’s easy to transfer memberships, it can be difficult to transfer ownership.

Profits are taxed immediately. There’s not an option to instead reinvest profits, as you can with a corporation.

Some states restrict certain types of businesses from forming an LLC.

Where Should I Form a Limited Liability Company?

You form an LLC with your secretary of state. The filing fee may vary from $40 to $500 depending on where you live. Filing requirements may vary according to state law.

Before you file, you’ll need to name your LLC, and also write your articles of organization and operating agreement.

What are the Different Types of LLCs?

There are many different types.

Single Member LLC: This is like a sole proprietorship with benefits. The sole proprietorship doesn’t protect its owner from liability, but the single-member LLC does.

Member Managed LLC: profits and losses go to members (pass-through taxation), and members run the company. The LLC is a type of multi-member LLCs.

Family Limited Partnership LLC: The LLC is owned by family members as in multi-member LLCs.

Professional LLC: The LLC is managed by a manager.

Restricted LLC: This type of LLC only exists in Nevada. The LLC cannot distribute profits until it’s been in operation for 10 years.

L3C Company: The LLC is for-profit but with the philanthropic distribution of profits.

Anonymous LLC: This type of LLC only exists in New Mexico. The ownership details are not on any documents.

Non-Profit LLC: The LLC is a nonprofit with 501c3 status.

Series LLC: The series LLC is available in 8 states. A series LLC is organized by internal segments, such as members, managers, assets, and interests. Profits are shared by members.

General Partnership LLC – The LLC is a multiple-member LLC.

Limited Partnership LLC – There are at least two members, one is a general partner and one is a limited partner. Usually, the limited partner is a silent partner.

What Type of Business Entity Could I Form Instead of an LLC?

You can form a partnership for a business that isn’t an LLC, or you could form a corporation – a c corporation or an s corporation. Here’s a look at how each type of business entity is different from an LLC, and from each other. In each, the ownership structure is different.

Partnership: As with an LLC, you can have a general, limited or limited liability partnership. With a limited partnership, the partners report to a general partner. In a general partnership, all owners are equally responsible for debts and profits. The limited liability partnership protects personal assets. So why do an LLC instead? The paperwork is easier.

S Corporations: The S Corporation issues stock and owners are shareholders. An S corporation also provides liability protection for owners. S Corporation owners are taxed based on the number of shares they own. The S Corporation owners must report earnings on their personal income tax returns.

If you are asking should I elect S Corp status for my LLC, it is always an option as your business continues to grow.

C Corporations: The C Corporation is an incorporated business that is taxed separately from its owners, who are also taxed. The C-Corporation also provides liability protection for owners. Employees of C Corporations have stock options and benefits. Business owners may choose limited liability companies for tax purposes instead of C Corporations to avoid double taxation of their company.

How to Form a Limited Liability Company (LLC)

Limited Liability Companies must be filed with the secretary of state where the companies are formed.

You’ll need to have developed your articles of organization, which include the names of all members and management, your company name and address, and the name and address of your registered agent.

You’ll need to have also developed your operating agreement, which establishes the rules and bylaws of the company. The operating agreement also includes the details of the company management and the business plan for company operations.

For more information on these topics go to How do you Create an LLC.

After you’ve formed and done the filing for your LLC business entity, you’ll have some additional steps to take: Check out 10 Things You Need To Do After Forming An LLC.

Management and Business Structure of an LLC

Corporations have structured management and business structures. For example, there are meetings of boards of directors of corporations, and the content of the corporation meetings must be noted in writing and recorded.

LLC structures are generally not as strict as they are with corporations. That’s because the owners or members who establish the LLC set the guidelines for the LLC companies. That’s not to say that an LLC can’t have a board of directors, similar to a corporation setup.

There are two main types of LLC business structures. With either structure, the members can decide to have a board of directors. Members will have voting rights based on their amount of capital investment in the company.

Member managed

Typically this type of LLC structure has a small number of members. Usually, each member has the experience and wants an active role. This is a good choice for small businesses.

Manager managed

In this LLC structure, one person is chosen as manager. The person chosen as a manager can be a member or non-member. Members can replace the manager and that is typically done by vote.

How Much Does it Cost to Form an LLC?

Depending on the cost from state to state, the cost to file can vary from $40 to $500. LLCs are filed with the secretary of state.

You’ll incur additional costs of course if you elect to hire a lawyer and/or accountant. You may need an accountant to advise you of the tax implications of the various types of LLCs and corporations setups.

How are LLCs taxed?

All LLCs provide asset protection and all are taxed. The tax classification depends on the structure of the LLCs:

If there is only one member the LLCs are taxed as a sole proprietorship. In tax lingo, the single-member LLCs are called “disregarded entities” and profits and losses are reported on Schedule C of tax returns.

If there are two members, the LLCs are taxed as partnerships.

Multi-member LLCs are taxed as partnerships. The members must report LLC profits and losses using two forms, 1065 for overall figures and Schedule K-1 for individual figures.

A C-Corporation is taxed as a business. C-corporation owners also report income on personal taxes. Company debts and profits must be reported. This is double taxation.

For an S corporation, owners are shareholders. The owners report their share of the income on Schedule K-1.

Should I Change my Sole Proprietorship to an LLC?

The main reason to join the ranks of limited liability companies would be to protect personal assets.

If you are a sole proprietor, you may be able to enjoy a low-income tax rate. However, you are also liable for business debts. If you have business debts as a sole proprietor, creditors may be able to go after your personal property.

Want more in-depth information? Go to How to Change Your Sole Proprietorship to LLC: 6 Easy Steps.

How do LLC owners get paid?

LLC owners get paid by their share of the profit. The owners or members are paid via a distribution that passes from the LLCs to them. They must report the income from LLCs on their personal income tax return that they file.

If the LLC is an S corp, the company issues stocks and the owners are taxed based on the shares that they own.

If the LLC is a C Corp, the owners are taxed based on their earnings with the company.

What is a registered agent?

A registered agent is a person appointed by the leaders of the LLC. The registered agent accepts legal documents on behalf of the business. To fulfill that role, the person must be available during business hours.

The registered agent must be filed with the state when the LLC information is filed. The person must be registered in the state as a registered agent, and be a resident of the state.

What is an LLC operating agreement?

The LLCs operating agreement spells out the roles of the owners, manager, and members. The agreements also include the bylaws of the LLCs, and management and operations details of the LLCs.

How do you prepare an operating agreement? For more info, go to Does Your LLC Need an Operating Agreement?. To learn more about what should be included, check if amending an LLC operating agreement is the right step for you.

Do I need a lawyer to form an LLC?

That depends on how complicated your LLC is. Is it a single owner? You can probably walk yourself through it.

If you’re going to have a complicated operating agreement or a multi-member LLC, it may be best to retain a lawyer. Some of the paperwork – especially the annual refiling and reporting – can be daunting and it must be completed in a timely manner. Miss a deadline? You’ll have to file all over again.

And why shouldn’t business owners be free to concentrate on building the business? You can put all your legal matters into the hands of an attorney who’s well-versed in limited liability companies’ LLCs. There are lawyers who specialize in this LLC limited liability field.

Your lawyer may also be able to give you guidance as to which type of LLC is best for your business.

Should I form a partnership or an LLC?

Both a partnership and an LLC business provide limited liability protection.

A general partnership as a business operates under the names of the owners, as a joint venture. The owners share in profit and loss – and owners are personally liable for business debts.

What does an LLC protect your business from?

An LLC protects you from:

  1. Seizure of your personal assets. In other words, if your LLC business fails, creditors can’t put a lien on your house, or personal bank account or possessions.
  2. Double taxation. You’ll pay income tax on any profits the LLC makes (or on your share of the profits). You’ll report that income or loss on your personal income tax on Schedule C.
  3. Being named as involved in a business as an LLC member. LLCs don’t have to list the names of all their members on documents filed for the business.

Do I need an EIN number for an LLC?

Yes, if you’re a single-member LLC. In other words, if you’ve turned a sole proprietorship into a single-member LLC.

Image: Depositphotos

This article, "What is an LLC?" was first published on Small Business Trends



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