Limited Liability Company

A limited liability company (LLC) is a type of business organizational structure that protects the owners from the risk of losing their personal assets in the event that the LLC cannot pay its debts or financial obligations. In other words, LLCs limit your liability to the amount of capital you contributed to the firm, much like a corporation.

Two common types of limited liability companies are sole proprietorships and partnerships. LLCs have some tax benefits, such as allowing pass-through taxation and management flexibility. Every state in the United States and the District of Columbia allow for the formation of limited liability companies.

A limited liability company may be called a limited liability corporation, which is incorrect terminology. The correct terminology is “company,” not “corporation.”

Organization of the Limited Liability Company

Limited liability companies are common for a small business with a single owner. Owners are called members though they are similar to shareholders. An LLC can have one member—the owner of a sole proprietorship. An LLC can also have two or more members in a partnership. These members can only lose the amount of capital they invested in the company. That is the beauty of limited liability.

The membership interest is similar to shares of stock. Members have control over the LLC in direct proportion to the number of shares or units of membership they own. The management of an LLC is regulated by state laws and may vary from state to state.

Setting up an LLC is slightly more involved than establishing a sole proprietorship but not as challenging as setting up a corporation. You must file Articles of Organization with the Secretary of State of the state where you choose to exist. Also, you should have an Operating Agreement though it may not be required nor filed, depending on the state. The Operating Agreement specifies the rights of the members and the management structure of the LLC.

Advantages of a Limited Liability Company

1. Less Paperwork and Recordkeeping – Limited liability companies require much less recordkeeping than corporations. You do not have to have annual meetings, for example. An LLC also does not have to have a board of directors or officers.
2. Flexible Tax Treatment – An LLC is much more flexible from a tax standpoint than other forms of business organization. An LLC can elect to be taxed as a sole proprietorship, partnership, C corporation, or S corporation.
3. Limited Liability – The primary benefit of an LLC is its limited liability feature. The members of an LLC can only lose the amount of capital invested in the firm, meaning your personal assets, such as your savings and home, are not at risk.
4. Pass-through Taxation – There is no double taxation of earnings unless the LLC decides to be taxed as a C corporation. Double taxation means that earnings are taxed at the corporate level. Then, they are taxed again at the shareholder level. If an LLC elects another form of business organization, it can avoid double taxation, and earnings will be taxed only at the personal level.

Disadvantages of a Limited Liability Company

1. Challenges with Financing - Sometimes, it can be challenging for LLCs to raise money or get financing. Some banks require the members, or one member, to personally guarantee a business loan, or the bank will not make the loan. The personal guarantee means your personal assets are potentially liable if your business can't repay the loan, which negates the limited liability feature of an LLC.
2. Unfamiliar Management Structure - Members of an LLC may be called shareholders, members, or other titles. The management structure of an LLC may be unfamiliar to creditors and others in the business world. This problem makes it difficult for others in the business to determine who has managerial authority and responsibility for the LLC.
3. Fees to Establish and Maintain - Many states charge a formation fee, renewal, or annual reporting fees, making LLCs more expensive to maintain than sole proprietorships.
4. Self Employment Taxes - Depending on how the LLC is established, owners may need to pay self-employment taxes, which are the taxes that fund Social Security and Medicare. The self-employment tax might be in addition to the owner's personal income taxes. Please consult a tax professional to determine the best business and tax structure before forming an LLC.

A limited liability company is an option that small business owners should look at when deciding on their business structure. The small business owner should consider all the taxation, accounting, and legal ramifications before making a decision.

Frequently Asked Questions (FAQs)