Call us on

Understanding Limited Liability Company (LLC)

  Sanjiv Gupta CPA  Published 
Understanding Limited Liability Company (LLC)

A Limited Liability Company (LLC) is a relatively new form of business structure. The LLC combines the simplicity and flexibility of a sole proprietorship or partnership with the limited liability protection afforded by a corporation.

What is an LLC?

An LLC is a legal entity similar to a corporation, but which has fewer formalities to comply with. It is an alternative to the more widely used corporation, or S Corporation, for small businesses. A limited liability company offers personal liability protection to its owners (called members) similar to that of a corporation, but with fewer formalities and less expense.

Why should I form an LLC?

An LLC offers its members liability protection as well as flexible management, distribution of profits and ownership transferability. Members may participate in the management of the LLC or hire managers to run it for them. The owners can divide up responsibilities any way they want without having to worry about disrupting the business focus because they are all part of one legal entity.

How do I form an LLC?

To form an LLC, you need to file papers with the Secretary of State and create an Operating Agreement. If you intend to do business under a name other than your own individual legal name or the legal name of your LLC, you must register that fictitious business name (called a DBA: doing business as).

What does it cost to form an LLC?

The current fee for filing documents with the Secretary of State is $60 (varies by state, check the SOS website). Some lawyers charge as much as $5,000 to prepare the necessary documents, but there are many CPAs who will do it for considerably less. Unless you really need a lawyer's services, use your accountant or CPA  as an inexpensive yet knowledgeable source or ask other business owners who they use.

What are the filing requirements when forming an LLC?

To form an LLC, you must file Articles of Organization with your state's Secretary of State. This requires information such as the name and address of each owner/member in the LLC, the name and  address of the registered agent and any fictitious or assumed name that will be used in business. There may also be a filing fee to file these documents, which can vary depending on where you live.

How do I pay taxes as an LLC?

You'll complete IRS Form 1065, U.S. Return of Partnership Income, and send it to the IRS. Part of this return shows your personal tax liability as a member, but another section shows how much profit or loss each member has earned. You must also file a Schedule K-1 (Form 1065) with each LLC member's individual income tax returns reporting their share of profits and losses.

LLC Taxes

LLCs are taxed similar to a partnership. The LLC itself does not pay taxes, but members report their share of profits and losses from the LLC on an individual income tax return each year. This is why it's important for every LLC member to have a thorough understanding of the company financials, in addition to having a copy of the LLC Operating Agreement.

How do you transfer ownership of an LLC?

An LLC is a legal entity so it's possible to transfer ownership to another person or company. You can use a buy-sell agreement that defines how the business will be transferred when an owner dies, retires or decides to sell his interest in the company.

What are some disadvantages of an LLC?

LLCs have the same limitations as corporations. These include double taxation, which can occur when money is distributed to members and taxed at each member's individual tax rate on the way out. This also means that losses in one fiscal year can be applied to offset future profits, so if you have poor years, your LLC can't carry forward the loss to future years.

LLC Operating Agreement

The LLC Operating Agreement is an internal document created by the owners of the company that dictates how they will govern themselves. The agreement should include effective dates, termination terms and provisions for passing along membership interest to successors or other members if an owner retires, dies or sells his share of the company. This is important to have in place because an LLC legally dissolves if there are no members left.

What happens to my LLC if I die?

You can leave your ownership interest to family members or friends through a Will or trust agreement, which lets you choose who will inherit your interest in the company. If you don't leave a written agreement, state law will determine how your ownership interest is distributed when you die.

What if I want to change my LLC Operating Agreement?

Your LLC Operating Agreement should be reviewed and updated at least once every two years or whenever there's a major change in the company's operations. It should be reviewed after a new board member is added, you take on a new partner or add or remove an internal process.

How can I protect my LLC from lawsuits from members?

LLCs provide limited liability so only your assets inside of the business are at risk. If you have personal assets that can be at risk, you should form an LLC as a separate business entity. This way, if someone sues your company and wins, he'll only be able to seize assets such as equipment inside the business. Your personal assets (such as your house) won't be seized.