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Limited liability company (LLC)

A limited liability company (LLC) can be formed by a small business owner to separate their legal and financial liabilities from those of their business, providing a degree of protection.

What is an LLC?

More specifically, LLCs can help shield business owners from debt, lawsuits, or bankruptcy their business may face. In fact, forming an LLC can benefit a wide range of small businesses and can provide a major advantage over sole proprietorship.

If your business is run as a sole proprietorship, any of your personal assets are treated as part of the business for any financial liabilities such as debt, lawsuits, or bankruptcy. Your personal assets and business assets are essentially one and the same.

If your business is an LLC, your LLC is a business entity that’s a separate legal entity from yourself. Your personal liability and financial liability are protected from your business's debts and liabilities.

LLCs provide legal protections similar to those of corporations, but with fewer restrictions. The owner of an LLC isn't required to have a board of directors, shareholder meetings, or maintain the same level of documentation that’s required of a C corporation.

Forming an LLC operating agreement

To create an LLC, you’ll have to file articles of organization with the Secretary of State’s office in the state where the LLC operates, according to state laws. Your LLC filing will require filing fees and annual fees. The average annual filing fee in the United States is less than $100.

Many LLCs have an operating agreement that serves as the articles of organization and defines the business structure of the LLC, the relationship between the LLC owners, their duties, rights, and responsibilities.

Whether you have a single-member LLC or a multi-member LLC, you’ll likely need a registered agent who can accept the LLC’s tax and legal documents for tax purposes and other business requirements. The agent can be one of the members of an LLC, or someone designated to help manage the business, such as a lawyer or an accountant.

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How does an LLC pay taxes?

An LLC can have any number of owners and typically provides income to the owners on a pass-through basis, just like a sole proprietorship or partnership. Income that members receive from an LLC is usually reported on their personal income tax return.

However, an LLC can also choose to be taxed as a corporation, with the members treated as employees and the LLC tax return filed separately from individual tax returns.

How are LLCs regulated?

Each state restricts the types of businesses that can form an LLC, with all of them forbidding banks and insurance companies. Some states require LLCs to pay an annual fee costing hundreds of dollars, and to file paperwork each year, or every other year, with information on their business activities. More information can be obtained from the Secretary of State’s office in your state.

LLC vs. S corporation: What’s the difference?

Both LLCs and S corps, also known as an S subchapter, are often used by small business owners for their legal and financial advantages. While each allows the pass-through income of company profits and provides some liability protection for the owners or shareholders, there are differences between the two.

LLCs are easier to create and don’t have to abide by Internal Revenue Service (IRS) restrictions on the number and types of shareholders or members. LLCs are typically used by sole proprietors or partnerships, such as landlords, attorneys, and accountants. LLCs also face no restrictions when it comes to divvying up profits.

While S corps require more paperwork and restrictions, they have the upper hand in terms of financing. S corps can sell shares to investors, whereas LLCs typically rely on bank loans. S corps also have to report their earnings and file federal tax returns, even though they are largely exempt from corporate income taxes.

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