A limited liability company (LLC) is a business structure that offers limited liability protection and direct taxation. As with corporations, LLCs legally exist as separate entity from their owners. Therefore, owners typically cannot be held personally liable for business debts and liabilities.
LLC allows direct taxation as its income is not taxed at the business level; however, if the LLC has more than one owner, a tax return must be filed for the LLC. Any LLC income or loss is shown in this statement will be passed on to the owner(s). Owners also called members, must then report their income or loss on their personal tax return and pay any required taxes.
Benefits of forming an LLC
Unlike operating or forming a sole proprietorship or general partnership, the benefits of creating an LLC often outweigh the perceived disadvantages.
Limited liability: Members (who are the owners of an LLC) are protected from personal liability for the actions of the LLC and its other members. Creditors cannot follow the personal assets of the owners (housing, savings accounts, etc.) to pay their commercial debts. Personal assets of individuals and general partners can be followed up against the debts of the enterprise. Note: It is possible for an LLC (and a corporation) to forfeit limited liability.
Flexible membership: Members can be individuals, partnerships, trusts or companies and there is no limit to the number of members. S corporations (a corporation that chooses to be taxed as a pass-through entity under Subsection S of the Internal Revenue Code) are much more restricted in who can be shareholders, and there is a maximum limit on the number.
Management structure: Members can manage the LLC or choose a management group to do so. Corporations, on the other hand, are run by a board of directors, not shareholders. When an LLC is member-managed (a "member-managed" management structure), the owners oversee the day-to-day business operations. When managed by appointed directors (a "manager-managed" management structure), an LLC is similar to a corporation in which the management of the business is the responsibility of directors and officers rather than owners (shareholders).
Direct taxation: LLCs generally do not pay business-level taxes. Any business income or loss "passes" to their owners and is reported on their personal income tax returns. Taxes due are paid at the individual level. Corporations that cannot or choose not to be taxed as an S corporation (they are known as C corporations because they are taxed under Subpart C of the IRC) are taxed at the business enterprise level and their shareholders are taxed on the income distributed to them.
Increased credibility: Starting an LLC can help a new business build more credibility than if the business is operated as a sole proprietorship or partnership.
Limited compliance requirements: LLCs face fewer government-imposed compliance requirements and ongoing formalities than sole proprietorships, general partnerships, or corporations (which are taxed as S corporations or C corporations).
Disadvantages of forming an LLC
There are also a few downsides to creating an LLC, but in most cases, the advantages outweigh the disadvantages.
Cost: An LLC usually costs more to set up and maintain than a sole proprietorship or general partnership. States charge an initial formation fee. Many states also impose recurring fees, such as annual reports and/or franchise tax fees. Check with your Secretary of State's office.
Transferable property. Transferring ownership in an LLC is often more difficult than in a corporation. In joint-stock companies, shares can be sold by the company to increase ownership, and shareholders can sell their shares to someone else unless there is a contrary shareholding agreement. Typically, in LLCs, all members must approve adding new members or changing ownership percentages of existing members, unless the members agree otherwise.