What are limited liability companies?

A limited liability company (LLC) is a business entity created by state statute. There are no limits on the number of members that can join a limited liability company and there are no limits on the types of members that can join. This means that it is possible to form an LLC with only one individual member. This also means that it is possible to form a limited liability company with many members. The members can consist of both individuals and business entities.

A limited liability company combines the best aspects of a corporation with a partnership or sole proprietorship. Choosing an LLC as your business entity will give you the flexibility offered by the management and tax structure of a sole proprietorship or partnership, while also providing you with the limited liability of a corporation.

Advantages of Forming a Limited Liability Company

One advantage of forming an LLC over a partnership or sole proprietorship is that you receive the benefit of limited liability protection. This means that you are only liable up to the amount of your investment in the limited liability company, and your business debts stay within the business. Limited liability prevents creditors from being able to reach personal assets such as your residence or family car. However, it is important to remember that limited liability protection is not absolute. Some creditors will ask you to sign away your limited liability protection when you apply for a loan. If you refuse, this could cost you the loan.

Another way to lose the limited liability protection of an LLC is to mingle your business accounts with personal accounts or to treat the limited liability company as an extension of your personal affairs. This can be as simple as failing to keep up the business paperwork or any other required formalities agreed to under the operating agreement. You will also lose limited liability protection if you use the business as a shield for wrongdoing.

Limited Liability Company “Check-the-Box Taxation”

Another benefit of forming an LLC is that you get to choose the method in which your business is taxed. In most states, the default taxation method of an LLC is like that of a sole proprietor or partnership. This method of taxation is called pass-through taxation. This means that the business income “passes through” the entity itself, and is only taxed as the owners’ income. While the owners of the LLC will have to file a tax form 1065 for the limited liability company, this form is only for informational purposes and can be used as a check by the IRS on the owner’s claimed income that year.

Some business owners may choose to have the LLC taxed as a corporation. This is done by filing a form 8832 with the IRS, which elects corporate status for taxation purposes. This method of taxation is often called double taxation, as both the business entity as well as the owners’ income is taxed.  This method of taxation is useful for owners that want to keep the profits within the business to build capital. This means that any portion of the profits kept within the business are not received as dividends, and the owners are not personally taxed for these earnings. Because the entity is taxed at a lower rate than the owners are, this method of taxation is beneficial to the business in this case.

How to Form a Limited Liability Company

Formation of a limited liability company is fairly simple. To form an LLC, you will need to file the articles of organization with the appropriate state agency, usually the Secretary of State, and pay a filing fee. Articles of organization, also called certificate of formation, or certificate of organization, provides the state with basic information about the business, such as the business name, business address, and manager’s contact information. The filing fee for forming a limited liability company will depend on the state, but the LLC can be filed anywhere. Costs to form an LLC typically range from $100-$800. After filing your LLC with the state, you will need to obtain any business licenses or permits necessary to operate your business.

It is also highly recommended that you create an operating agreement. An operating agreement is not required by law and it does not need to be filed with the state. However, an operating agreement is an extremely useful and important tool in managing your LLC. Unlike state corporation statutes, which provide protective provisions for the members of the corporation, LLC statutes generally do not. Instead, most LLC statutes allow for the owners of the LLC to draft their management structure in any way that works for them, within the bounds of the law.

A good operating agreement should lay out the percentages of ownership, the duties of the individual members, the allocation of any profits made or losses incurred, and how interests are transferred if one or more member leaves the LLC. Because it is so important to have a solid operating agreement at the start of your business, you may want to consult with a business lawyer before you draft it. A clearly drafted operating agreement can save you a lot of headache down the road.

Terminating a Limited Liability Company

In some states, the statutory default provides that an LLC is terminated if one of its members leaves the entity. However, this general rule can be altered in an operating agreement by providing a buy-out provision. This means that if a member leaves, other members will agree to buy that members interest in the business. If the members determine that they all want to dissolve the LLC, they must divide all of the entity assets and pay all remaining debts. If remaining debts cannot be paid immediately, you should contact the business creditors to inform them of where to send the remaining bills. Finally, the articles of termination must be signed by all members and filed with the Secretary of State. Form 966 must be filed with the IRS to complete the process of terminating an LLC.