It’s relatively easy to organize a business as an LLC. LLCs range from small online shops to large, multi-level companies. If you are considering starting a business, check out the following answers to the most frequently asked questions about LLCs.
What Is an LLC and How Does It Work?
An LLC is a business structure recognized by the IRS but governed by state law. Let’s break it down by discussing what limited liability is and how this type of organization works.
What Does LLC Stand For?
LLC stands for “limited liability company.” As the name suggests, an LLC is formed to limit the liability to which its owners (known as members) are exposed. LLC members are shielded from being held personally liable for the activities of the business, meaning their personal assets are safe if the business fails.
LLCs vs. Corporations, Partnerships, and Sole Proprietorships
LLCs share similarities and differences with corporations, partnerships, and sole proprietorships.
LLCs and corporations both shield their members from liability, but corporations have more extensive filing, meeting, and taxation requirements. A corporation is subject to “double taxation,” meaning it pays taxes on its profits to the federal government, and the members also pay taxes on the money received from the corporation’s profits. Business income for LLCs, by contrast, “passes through” the LLC and is taxed as personal income.
Corporations subject to double taxation are known as C-corporations (or “C-Corps”). There is a special tax status called an S-corporation (or “S-Corp”), which avoids the double taxation. C-Corps and LLCs can claim S-Corp tax status to avoid double taxation.
Partnerships and Sole Proprietorships
Partnerships and sole proprietorship members are not shielded from liability for business activities. Like LLCs, business income “passes through” to the members for tax purposes, avoiding corporate double taxation. A sole proprietorship has one member, and a partnership has more than one.
How Does an LLC Work?
- LLCs are formed under state law by one or more members. The members choose an LLC tax status out of three options: Single-member LLC, called a disregarded entity (the default status for an LLC with one member)
- Multi-member LLC, or partnership (the default status for an LLC with more than one member)
- Corporation (C-Corp or S-Corp)
The term “disregarded entity” means the income from a single-member LLC passes through to the member. The IRS “disregards” the LLC as a separate entity and considers the profits of the business and the member’s personal income as the same thing. Partnerships are treated the same way but have more than one member.
An LLC can “elect” to be treated as a C-Corp or S-Corp for tax purposes. Electing C-Corp tax status allows some profits to be kept in the business (rather than being paid out to members) but avoids the administrative burdens of organizing as a corporation. The corporate tax rate is lower than the personal income tax rate, but in 2018 Congress introduced a lower tax rate for LLCs, sole proprietorships, and partnerships to even the playing field.
Members of LLCs treated as S-Corps are both owners and employees for tax purposes, while members of LLCs with default tax status are only considered owners. Members of an S-Corp LLC pay themselves a salary and a distribution from profits, but only pay employment taxes on the salary. As a result, a significant way S-Corp status helps an LLC is by lowering Medicare and Social Security taxes.
Each state has its own rules regarding LLC formation. Many states limit what types of businesses can be organized as LLCs, with the most common restrictions imposed on financial services companies such as banks.
Is There More Than One Type of LLC?
For tax purposes, an LLC can be treated one of three ways: as a disregarded entity, partnership, or S-Corp.
However, there are several ways an LLC can organize, which may or may not be permitted depending on the state. Common types include (but are not limited to):
- Single- or multi-member LLC, which is based on the number of owners
- Domestic vs. foreign LLC, which depends on whether the LLC is doing business in its home state or in a different jurisdiction
- Professional LLC, or PLLC, which is run by members who require licensure to operate (think doctors, lawyers, or accountants)
- Series LLC, or SLLC, which includes a parent or umbrella LLC and smaller LLCs under it
Is an LLC a Corporation?
Does the IRS consider an LLC a corporation? Yes, and no. An LLC is different than a corporation but can be treated like one for tax purposes. An LLC files as a corporation with the IRS by submitting Form 8832 and electing corporation status. Even if an LLC has been treated as a partnership or disregarded entity for years, it can change its status.
Can an LLC Have Two Owners?
An LLC can have an unlimited number of members. Furthermore, membership is not restricted to individual human beings, but can include corporations, other LLCs, or foreign entities.
Which LLC Is Right for Me?
Now that you know what an LLC is, you can determine which type of LLC is right for you. It may help to ask the following questions:
- Are you forming an LLC on your own or with others?
- Will you do business primarily in one state, or several states?
- Will you provide services requiring state licensure, such as medical care, accounting, or legal services?
- Do you want to keep profits in the company, or pay them out regularly to members?
An attorney or accountant can help you determine which type of LLC is the best choice.
How Do I Start An LLC?
Forming an LLC is as easy as filing paperwork with the Secretary of State where you want to do business. This involves choosing a state, naming your business, appointing a registered agent, and writing and filing the articles of organization. Many companies specialize in providing registered agents or formation services for you.
Once your paperwork is filed with the state, you’ll get a tax number known as an employer identification number, or EIN. You’ll use this number to open the required business bank account, register for state taxes, and hire an accountant. Again, every state has its own rules, and a formation company can take care of most tasks for you.
Ready to Form Your LLC?
Now that you know what an LLC is and how it works, let an experienced formation company help you launch your LLC today.