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What is a Limited Liability Company (LLC)?

definition

A limited liability company (LLC) is a business entity that provides a business owner with the tax benefits of a partnership or sole proprietorship, and the limited liability of a corporation.

🤔 Understanding a limited liability company

A limited liability company (LLC) can be a great tool for a small-business owner to have in their toolbox, because it keeps personal and business assets separate. Just like the name suggests, an LLC limits your personal liability and protects you in situations related to company debts or legal issues. It also provides popular tax benefits—taxes get passed along to the LLC’s members to be paid against personal income rather than through the corporation (aka “pass-through” taxes). This can be helpful to new, small or start-up business owners as you’re finding your financial feet. Setting up an LLC is fairly simple, which—in addition to the benefits and coverage it provides—is another reason for its popularity. You “become” an LLC by filing articles of organization (a legal operating agreement that outlines the details of the LLC) to create one. FYI, some company types, like insurance and banks, can’t operate as LLCs. Also, LLCs are state-regulated, and rules can vary from state to state.

example

Imagine you and your best friends from college decide to start a late-night snack delivery company together. Of course, you trust your friends, but you’re also worried about what would happen if the business were to fail. Not many people are really willing to bet the house (or the car) on a business idea, which is why becoming an LLC is a great idea in this case. No matter whether you guys become the next Jimmy John’s (FYI, also an LLC) or go bust by spring break, your personal assets are protected.

Takeaway

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.

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Tell me more...

How does an LLC work?
How does an LLC compare to a partnership?
What are the benefits of an LLC?
What are the disadvantages of an LLC?
Can owners of an LLC be personally sued or held liable in court?

How does an LLC work?

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 says that yours will, then be sure to do so—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.

How does an LLC compare to a partnership?

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.

What are the benefits of an LLC?

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 protect its members—Not only against liabilities, but also against other members of the LLC itself. Then, of course, there is the pass-through tax structure that can save you money, and what is possibly its biggest selling point to business owners—the ability to keep your personal assets separate from your company’s liabilities.

What are the disadvantages of an LLC?

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.

Can owners of an LLC be personally sued or held liable in court?

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 loophole 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—Although in a perfect world, this wouldn’t be an issue anyway, seeing as one of the reasons for forming an LLC is to create this separation in the first place.

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 their LLC itself. Is filing articles of organization all that is needed to start an LLC? 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).

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