What is a Limited Liability Company (LLC)?

Setting up an LLC is like getting a flu shot for your finances...

It helps protect your personal finances against liabilities that might hit your company in the future. And—just like a flu shot—the protection isn't absolute, but it usually helps.

An LLC is a behind-the-scenes business feature—It doesn’t impact the customer experience at all. It can be made up of a single owner, a group, or even a pre-existing corporation which is being reorganized. It’s formed by the creation and registration of an operating agreement called articles of organization.This sets the rules for how to treat the owners (usually called “members”) in legal matters. FYI, unlike corporations, in most states, LLCs aren’t required to hold annual meetings. But if its charter mandates annual meetings, then that is what should be done. Failure to follow through with this commitment could open you up to liability issues later. And LLCs are required to file either semi-annual or annual reports with their state registering agency.

One of an LLC's primary features is the choice it offers when it comes to tax. In this model, you can choose to pay taxes as a corporation or partnership, or have them pass through into personal income tax. Members’ salaries are also considered, for tax purposes, as business operating expenses rather than taxable wages.

An LLC is a formal, legally drafted entity, which is bound by the charter created by their articles of organization and which can be made up of one person or many members. Partnerships, on the other hand, can be as informal as two people working together in a partnership arrangement (aka general partnership). While partnerships can be formalized by an attorney, they don’t have to be—But an LLC can’t exist without getting the law involved.

Protections for members (of LLCs) and partners (in partnerships) also vary. In the case of an LLC, state regulatory agencies determine what protections it gets, For partnerships, protection depends on what kind of arrangement exists. FYI, in a general partnership, partner liabilities are the same as if they were a sole proprietor—personal assets can be on the hook for company debts.

An LLC’s legally binding structure isn’t just another way to put money in your attorney’s pockets. The formal operating rules and member responsibilities it lays out helps protect its members—Not only against liabilities, but also against other members of the LLC itself. There is also the pass-through tax structure with its tax-saving potential, and what is possibly its biggest advantage to business owners—the ability to keep personal assets separate from a company’s liabilities.

Any time it’s necessary to set something up legally, there are going to be costs involved. Depending on how much spare cash you’ve got lying around, this can put a financial strain on your personal finances. FYI, setup fees vary state by state and sometimes even by what kind of business the LLC creates. In a single-member LLC, you might have to cover any unemployment-tax costs yourself, too. LLCs don’t cover every liability risk, either—In some situations, a member can be held personally liable for fraud, negligence, or other circumstances. Further, business owners can’t usually cash or deposit checks made out to the company—They have to run them through the company’s bank account. Finally, while it’s not necessary to file meeting minutes (if your LLC has meetings), your state regulating agency may require some annual filing. Check your state’s specific requirements carefully—Just as is the case with fees and rules around LLC setup, state laws vary on the filing requirements, and you should consult with an attorney to understand your obligations and what form of ownership is right for your company.

LLCs are popular for the conveniences and protections they offer to their members, but they’re not bulletproof. There are times when a court can pierce the corporate veil and cut through the paperwork barrier that separates the LLC from its members. Those to whom the LLC owes money may attempt to use this legal approach to try to go after personal assets, if the LLC itself has insufficient funds to cover its debts. FYI, this is much easier for a creditor to do when personal assets or accounts have been allowed to merge with the LLC’s.

In the case of personal fraud or negligence, the LLC won’t shield the guilty party either, because the trouble arose from their actions. It might cover the other members, though. You’re on the hook for unpaid taxes, too—an LLC is no match for the IRS’s might. Again, both of these liabilities can vary depending on the situation, the state, and the LLC’s setup.

Signing contracts is another situation that could open a member to being sued or held liable. How the contract is signed can matter as much as the content within it—If a member neglects to include the LLC’s name or some other notation that they’re signing as its agent, a court could consider them to be the legally responsible party for the contract, rather than the LLC itself.

Forming an LLC requires filing the articles of organization and operating-agreement forms, and paying any necessary fees. FYI, if your LLC has two or more members, you’ll also need to complete IRS form 8832 to select how you intend to file your taxes (the IRS treats an LLC with two or more members as a partnership, but members can also opt for it to be treated as a corporation or a disregarded entity).

It is very important that you consult a competent attorney and tax advisor when making these important decisions.