What is an LLC? A complete guide to the Limited Liability Company

What exactly is an LLC?

A limited liability company (LLC) is a common U.S. business structure, registered at the state level, that combines personal asset protection with flexible management and simple taxation.

The LLC owners are called members. An LLC can be owned by one person (single-member LLC) or multiple people (multi-member LLC), making it easy to start small and grow over time. An LLC can also own other LLCs and can be listed as a member of another LLC. Owners don’t have to be U.S. citizens or residents, either: non-US residents can form an LLC too.

One of the main benefits of an LLC is limited liability protection, which generally separates your personal assets from your business debts and legal claims. LLCs are also typically taxed as pass-through entities, meaning profits and losses are reported on the owners’ personal tax returns rather than taxed at the business level.

By default, the federal government taxes an LLC as a sole proprietorship or partnership, depending on how many owners it has (IRS). What makes an LLC unique from a tax perspective is its flexibility. You can choose to be taxed as an S corporation (if you qualify) or a C corporation if doing so becomes more beneficial as your business grows.

When you form an LLC, you need to keep up with a few ongoing requirements to protect your personal assets. This usually means having a registered agent who can receive official mail for your business, and filing any required annual reports or paying state fees so your LLC stays in good standing.

Why is an LLC so important?

One of the most important decisions you’ll make when starting a new business is choosing a structure, also known as a business entity. Many small business owners opt for forming an LLC as it’s inexpensive to form and relatively simple to maintain.

But the LLC structure supports you in other ways too. It protects your personal assets if the business runs into trouble. An LLC also gives your business an air of professionalism and can help obtain funding when you need to expand.

The LLC structure exists to help business owners like you think big and plan for the future. Here’s what an LLC is and what it’s good for.

Key points about LLCs

• Provides personal liability protection for owners (members).
• Offers pass-through taxation, meaning profits and losses are reported on members’ personal tax returns.
• Can have one or multiple owners.
• Fewer formalities and ongoing compliance requirements compared to corporations.
• Flexible management structure where members can manage or appoint managers.
• Can do business in any state, though it must register as a foreign LLC in states outside the one where it was formed.
• LLCs can be taxed as a sole proprietorship, partnership, or corporation, depending on the choice of the owner.

LLC as a business structure

Before you start your business, you must first choose your business structure and register with your state.

Factors that can influence your structure choice include whether you’ll have employees, need funding, and aspirations for future growth.

You have several business structures to choose from.

1. LLC
2. Corporation (C or S corporation)
3. Limited liability partnership
4. General partnership
5. Sole proprietorship

It’s the balance of flexibility and protection that makes an LLC a popular choice for small businesses. In addition, there are several types of LLCs, which makes it even more flexible.

And there are many other benefits, too. But first, when should you consider forming an LLC?

When should you consider forming an LLC?

Anyone starting a new business or already doing business without limited liability should consider forming an LLC. You can use an LLC structure to run almost any type of business.

What are the benefits of an LLC?

Although the LLC structure has some disadvantages, the benefits often outweigh them.

Choosing an LLC as your business structure can help you in several ways.

1. It helps to protect your personal assets against a lawsuit.
2. LLCs are relatively easy to form and maintain.
3. It avoids double taxation by default (unless you choose C corporation taxation).
4. An LLC offers flexibility, as you can tailor the management structure to suit your needs.
5. You’ll get exclusive use of your LLC name in your state.
6. It can help you access a variety of business loans.
7. It increases your business credibility with creditors and customers.

Limited liability

As an LLC owner, you may not be personally liable for your business’s financial losses, debts, or in the case of litigation. It might be that the only potential loss will be the capital (cash, assets) invested in the company.

Because an LLC is a separate legal entity, it can own property, sign contracts and keep its profits.

However, it’s always advisable to consult a lawyer once your LLC is set up to understand how to properly manage it. There are cases in which you could be held personally responsible for losses or litigation, such as if you’re found guilty of running your business fraudulently or not separating your business transactions from personal ones, known as “piercing the corporate veil.”

Simple to set up

An LLC is easy to set up and maintain because it isn’t required to hold annual meetings, assign formal roles, record company resolutions or minutes of meetings.

You only need to take a few steps to establish your LLC.

• Choose a name for your LLC
• Choose a registered agent
• File articles of organization (a certificate of organization or formation in some states) with your secretary of state
• Create an LLC operating agreement
• Apply for an EIN and comply with other tax and regulatory requirements

Pass-through taxation

LLCs pay tax as a pass-through entity. This means all profits flow through to the members, who pay income tax on their share. Members who work in the business usually pay self-employment tax on it too.

Which business types qualify as a pass-through entity?

U.S. businesses taxed as pass-through entities include sole proprietorships, partnerships, limited liability companies, and S corporations.

Pass-through entities are also called flow-through entities and fiscally transparent entities.

The takeaway: by default, an LLC doesn’t pay federal income tax itself. Some states still charge LLCs an annual tax or fee, such as California’s $800 minimum franchise tax.

Flexibility

All businesses are subject to laws they must follow. But LLCs are unique because members can write their operating agreement to change the default laws that govern them.

An operating agreement is a set of rules chosen by its members that outline how an LLC will run. You can divide the management roles equally or select a single member to act as manager (see member-managed vs. manager-managed LLCs).

An LLC also has flexibility with voting rights. You can choose to share managerial decisions based on the percentage of ownership each person has, and tailor the governance structure of your LLC to suit the needs and preferences of its members.

Exclusive use of your LLC name (in your registered state)

When you form an LLC with a state, your LLC’s legal name must be distinguishable from other businesses registered with the state, so no other registered entity can use it there.

However, registering your name in one state doesn’t protect it in the remaining 49. Nor does it prevent a general partnership or sole proprietorship from using your name in your state, but they can’t use it to form an LLC or corporation.

A federal trademark registration with the USPTO gives you nationwide rights to use the name for your goods or services.

Easier to get loans and credit

While forming an LLC is relatively cheap, many businesses require funding to run and expand into other markets.

Once you form your LLC, you can begin to build a credit history, helping you access business loans and other lines of credit as and when you need them.

Numerous loans are available, but your approval often depends on whether you have collateral, how long your LLC has been trading, its annual revenue, and your business’s credit score.

Business credit

Your business can have a credit score similar to an individual. Business credit bureaus such as Dun & Bradstreet, Equifax and Experian hold these scores so creditors, insurance companies, suppliers, and various other organizations can evaluate your financial standing and ability to repay a loan.

Increased credibility

Many businesses and consumers often consider unregistered businesses, such as sole proprietorships and many general partnerships, “unprofessional.” Of course, it isn’t true, but it’s an unfortunate reality that isn’t good for a new business.

When people see LLC after your name, they know you’re a registered entity within your state and are often far quicker to put their confidence in your business.

What are the disadvantages of an LLC?

The LLC structure exists to make life easier for small to medium business owners, so there aren’t too many disadvantages.

But it’s never all smooth sailing, so here are the potential bumps in the road.

Harder to raise money

While owning an LLC can help you get a business loan, it’s not a guarantee.

Most venture capital funds prefer to invest in C corporations, which can issue different classes of stock. An LLC sells membership interests (sometimes called units) instead of stock, which some investors find harder to work with.

Banks also look closely at new LLCs. Because members aren’t personally liable for the LLC’s debts, lenders often ask new owners to sign a personal guarantee for a business loan.

Setup cost

LLC setup costs vary depending on which state you’re trading in and your business model. Every state charges an initial formation fee, and many also have ongoing expenses, including franchise tax and annual report fees.

And there are other costs worth considering before opting to form an LLC. You can find out what yours are by visiting your state’s website.

Here are 5 standard costs.

1. State filing fee

When forming an LLC, your primary setup cost is the fee for filing your LLC’s articles of organization with your Secretary of State. Fees vary depending on your state and range from $35 to $500 (Tennessee charges $50 per member, at least $300). Find out more on your Secretary of State’s office website.

2. Registered agent fee

A registered agent is a business or person designated by an LLC to receive legal documents, official government correspondence and accept service of process on the business’s behalf.

You must name a registered agent when you file your articles of organization with the secretary of state.

Many LLC owners hire a registered agent service rather than take this role for themselves for a few reasons.

1. An agent’s address is a matter of public record.
2. Agents must have a physical street address in the state of registration.
3. Someone must be available at that address during business hours to accept legal papers.

Registered agent services typically cost $50–$300 a year, depending on the services you require and the number of states you’re trading in. Tailor Brands’ registered agent service is $199 a year.

3. Business license and permit fees

Most businesses require licenses and permits from state, municipal and/or federal agencies.

Each state has different license and permit requirements but one thing every state has in common is that, if you don’t comply, there are costly consequences. This can include fines, penalties, late fees, and in the worst-case scenario, the denial to operate.

So, it’s important that you find what permits and licenses you’ll need before trading. Your requirements and fees vary based on your location, business activities, and government rules.

License costs vary widely by city, state and industry, from free in some places to several hundred dollars or more for regulated industries.

Filing for a business license varies by license/permit and state. You’ll find the information for obtaining a business license on your county, state, and federal websites.

A word to the wise: it’s highly advisable to seek legal counsel to confirm which licenses and permits apply to your LLC business to avoid unnecessary violations and costs.

4. Operating agreement

An LLC operating agreement is a blueprint for the business structure and a record of each member’s share, management responsibilities, duties and contributions, daily operations, and what happens if a conflict arises or a member needs to leave the business.

Most states don’t require an LLC to draw up an operating agreement, but a few do, including New York. And while not creating one might sound like the easier option, it’s in your best interest to have one.

The best time to make an operating agreement is when you form your business, before you start trading.

The cost of creating an operating agreement varies depending on its complexity, such as the number of members, their percentage ownership, and designated duties.

Fortunately, an LLC operating agreement doesn’t usually need to be notarized, though you may want an attorney to review it and advise you on state rules.

The takeaway is that while an operating agreement will take some effort to create, it’s time well spent.

5. State differentiation

You can form an LLC in any state, regardless of where you’re doing business. However, for simplicity’s sake, your home state is often your best option.

The pros of registering in your home state: by forming an LLC in your home state, you have the convenience of familiarity with local state laws and procedures. You’ll probably have contacts there that can advise you. And all necessary government offices are within reach should you need to talk with an official.

Forming in another state and doing business in your home state has some downsides.

1. If you form in one state and do business in another, you’ll usually have to register there as a foreign LLC; fees run from $50 to $750, depending on the state.
2. If a state finds your business trading while not registered, it could impose penalties and back fees.
3. And you’ll have to designate a registered agent in that state, amounting to additional costs.

Now, this doesn’t mean registering your LLC in another state is out of the question; you have to weigh other factors like convenience to ensure it’s worth your while.

Lower tax is often the reason people choose to form an LLC in another state. For example, Wyoming is a business-friendly state with no personal or corporate income tax and a 4% state sales tax (plus local taxes). But if you live and operate elsewhere, you’ll still owe your home state’s taxes and register there, so forming out of state rarely saves money for a local business.

Self-employment tax

As a member who works in the business, you usually pay self-employment tax, which covers your Social Security and Medicare taxes. It’s calculated on each member’s share of the LLC’s net profit, whether or not you take the money out.

Self-employment tax is 15.3% (12.4% Social Security plus 2.9% Medicare) on 92.35% of your net earnings. The Social Security part stops at $184,500 for 2026; the Medicare part doesn’t, and an extra 0.9% applies above $200,000 ($250,000 for joint filers).

The downside is that you pay both the employee and employer halves, which an employer would normally split with you.

However, as an LLC owner, you can deduct half of your self-employment tax from your taxable income (on your tax return), which levels the playing field and saves you some tax dollars.

Members who don’t work in the business may not owe self-employment tax on their share, but the rules for LLC members are unsettled, so ask a tax professional.

Always check the IRS website for the current year’s figures or work with a tax accountant to advise you on your tax requirements.

To wrap it up

If you’re still unsure, it helps to write a list of the advantages and disadvantages, starting with the ones above and adding your own.

An LLC structure is meant to make life easier for small to medium business owners. Even though forming an LLC might seem like a big step right now, it can give you and your business a legally protected base to grow from.

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