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Small Business 101: LLCs Explained

Finance

So many myths, misconceptions, and rumors abound about the benefits, disadvantages, and requirements of being a limited liability corporation (LLC).

Yes, becoming an LLC can provide legal protection and operational ease, but depending on your circumstances it can also  present disadvantages.

Here are some FAQs to help you ascertain whether becoming an LLC is right for you, and pointers on managing your business and legal obligations once you are established as an LLC entity.

What is an LLC?

As stated earlier, there are many misconceptions about what an LLC actually is. In its LLC Guide for Small Business, Business.gov defines an LLC as:

 "...a hybrid-type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.  The 'owners' of an LLC are referred to as 'members'. Depending on the state, the members can consist of a single individual (one owner), two or more individuals, corporations, other LLCs, and even other entities."


It’s also worth noting that LLCs are not recognized by the federal government for tax classification purposes.

"...all profits and losses are 'passed through' the business to each member of the LLC.  LLC members report profits and losses on their personal federal tax returns, just like the owners of a partnership would." Nevertheless, some states do charge the LLC an income tax.

What about L3Cs?

A relatively new form of incorporation that is gaining in popularity is the L3C (low-profit limited liability company) - this hybrid legal structure combines the legal advantages of the LLC, with the financial  benefits of a non-profit.  And while the L3C entity operates as a for-profit business, making money is not its primary focus.  The goal of the formal entity is to make it easier for businesses with a social mission to receive investments, including loans and grants, from charitable foundations. L3C entities are, as yet, only recognized in five states. Read more about L3C businesses at work in this article from CNNMoney.com: "For L3C companies, profit isn't the point".

Is LLC Right for My Business?

There is no right answer to this question - the decision to become an LLC depends on many factors such as your risk of liability, your tax obligations, business objectives, and so on.

Of the many business entities that owners consider, LLCs as well as Subchapter S Corporations (S-Corps) are two of the most popular. Read "Should My Company be an LLC, an S-Corp or Both?" to determine which features are most important to you and your company (it also features excellent insight into the true pros and cons of being an LLC).  You can also check out the detailed advantages and disadvantages of being an LLC on Business.gov.

Because the needs of every business are different, and the law varies from state-to-state, it's worth an hour or two with a knowledgeable attorney to investigate all of the issues that will affect your decision.

How do I Form an LLC?

You will need to pursue the process directly with your state. In fact, you are required by law to register your business with the state whether you choose to be a corporation, non-profit, LLC, or a partnership. And while each state has slight variations to forming an LLC, they all adhere to some general principles explained here.

Which State Should I Incorporate In?

Typically, if you only operate in one state, you should incorporate in that state. If you operate in multiple states, you should determine which state is the friendliest to corporations and incorporate in that state. Read more in "Which State is best for My Small Business?".

Find out how to incorporate in your chosen state by following the state-by-state links here.

How do I Pay Myself in an LLC Structure?

How you pay yourself through your LLC depends on your own particular circumstances, so it’s always recommended that you consult a tax professional.

If you are a single member LLC, the practicalities of payment and taxation are relatively straightforward because the IRS requires that your earnings are reported on your own personal tax return, as if you were a sole proprietor. The mechanics of paying yourself start with maintaining a separate business and personal checking account (merging them just exposes your personal assets to liability), and then you simply pay yourself by writing a check from your business account to your personal account. Remember that all your business expenses should be also be paid from your business checking account.

Read "Paying the Boss: 4 Tips for Setting Your Own Salary" for tips on how and what to pay yourself as a small business owner.

If you are a multi-member LLC, your situation is likely unique to your business, so your best advice is to talk to an accountant.

What About Filing Taxes as an LLC?

In the eyes of the federal government, an LLC is not a separate tax entity, and therefore the business itself is not taxed. Instead, all federal income taxes are passed on to the members of the LLC and are paid through their personal income tax. While the federal government does not tax income on an LLC, some states do, so check with your state’s income tax agency.

For quick guidelines on how to classify your LLC for tax purposes, plus other filing tips and forms visit the LLC Guide for Small Business on Business.gov.

What Happens if I Move to a New State?

If you wish to re-locate your business to a new state you will need to attend to some administration with regard to your LLC structure and where it is registered. Read "Moving to a New State: A Small Business Relocation Checklist" to understand your options for continuing, dissolving, and establishing an LLC in your new state.

What Happens to the LLC Entity if I Change Business Direction?

If you have decided to do an about-turn in your business and want to run a new line of business through an existing LLC, start by checking your articles of organization and state's business registration web site to see what laws apply in your locality. Each state has different laws, but at a minimum if you change your business name you will need to notify your state and file a new business name registration form (DBA).

In some instances you may also need to get a new Employer Identification Number (EIN). Read more about business structures and the tax ramifications of operating or changing a formalized entity here (scroll to bottom of page).

Got More Questions about LLCs?

Post a question on the Business.gov Community of more than 9,000 business owners and industry experts.

Additional Resources

  • IRS.gov LLC Resources and Information

Relevant Articles

  • Differences in Legal Structures - Which Structure is Right for You?
  • The Better Choice for Entity Selection: LLC or S Corporation?
  • Three Ways to Lose Personal Liability Protection -- And What to Do About It
  • LLC Operating Agreements - The Basics
  • How to Register Your Small Business in Five Steps
  • Selling Up and Moving On - Preparation Tips for Making Your Business Sale a Success
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Profile: Caron Beesley

Caron Sharp has over 14 years of experience working in marketing, with a particular focus on the government sector. She writes the Government Resources for Business blog on AllBusiness.