What Is an LLC? Pros and Cons of a Limited Liability Company
A limited liability company (LLC) separates a company from its owners. This protects the owners’ personal assets if the business loses money or gets sued.
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Managing Editor An LLC is a business structure that combines some of the benefits of a partnership and a corporation. Like a partnership, an LLC allows for certain tax advantages plus management flexibility. But, like a corporation, it also “limits” the liability of its owners.
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Owners of an LLC are called members, and they can be either individuals or other businesses. The number of members an LLC can have is not limited. An LLC with only one member is called a single-member LLC.
LLCs are formed at the state level and aren't recognized as a tax structure by the federal government. The owners of an LLC may choose how they want the company to be taxed — either as a C corporation, S corporation, disregarded entity (the default for single-member LLCs) or a partnership (the default for multi-member LLCs).
» MORE: LLC vs. corporation
LLC benefits and drawbacks
Pros
Limited liability: Members’ personal assets are protected from creditors seeking to collect from the business.
Easier tax filing: Profits go directly to the members without being taxed by the government on the company level.
Management flexibility: Member-owners can be as involved in the management of their business as they want since they can choose to be members or outsiders.
Easy startup and upkeep: It varies by state, the initial paperwork and fees for an LLC are relatively light.
Cons
Limited liability has limits: A judge can rule that an LLC structure doesn’t protect your personal assets. You can be at risk if, for example, you don’t clearly separate business transactions from personal transactions.
Self-employment tax: If an LLC is taxed as a partnership, the government considers members who work for the business to be self-employed. This means those members are personally responsible for paying self-employment taxes.
Consequences of member turnover: In some states, changes in membership require an LLC to be dissolved and reformed. This process costs time and money.
» Check out our lists of the best LLC business loans and best business credit cards for LLCs
Types of LLCs
- Single-member LLCs. Entities with one owner who is responsible for the taxes, operations and debt of the LLC.
- Multi-member LLCs. Entities with multiple members who share responsibility for the business. They must all sign the company’s operating agreement.
- Member-managed LLCs. Entities that are managed by the members.
- Manager-managed LLCs. Entities with an outside manager hired to run daily operations.
- Professional LLCs. Entities with members in professions that are subject to state regulatory board licensing, such as CPAs, legal advisors or medical offices.
How to form an LLC
1. Choose a name
Register a unique name in the state where you plan to do business. To make sure someone else doesn’t have your business name, do a thorough search of online directories and county clerks’ offices. Also check the secretary of state’s website in your state and any others in which you plan to do business. For a fee, many states let applicants reserve an LLC name for a set period of time before filing articles of organization.
2. Choose a registered agent
A registered agent is a person you designate to receive official correspondence for the LLC. Choose a registered agent before filing your articles of organization; states generally require you to list a registered agent’s name and address on the form. Although people within the company usually can serve in this role, states maintain lists of third-party companies that perform registered-agent services.
3. File articles of organization
This step essentially brings your LLC into existence. States request basic pieces of information about your business. If you’ve thought through your business plan and structure, this shouldn't be difficult to provide. You’ll also supply details such as a name, principal place of business and management type as part of filing your articles of organization.
4. Get an employer identification number
The IRS requires any business with employees or that operates as a corporation or partnership to have an EIN. This is a nine-digit number assigned to businesses for tax purposes. The rule applies to LLCs because for federal tax purposes they're either corporations or partnerships.
5. Draw up an operating agreement
Your LLC operating agreement should include specific information about your management structure, including an ownership breakdown, member voting rights, powers and duties of members and managers, and how profits and losses are distributed. Depending on the state, you can have either a written or oral agreement. Many states don’t require an operating agreement but it’s useful to have one.
6. Establish a business checking account
It’s generally good housekeeping to keep business and personal affairs separate. Having a separate business checking account draws a bright line between the two. This is critical if you want to reduce any potential risk to your personal assets in the event of a lawsuit.
» MORE: How to pay yourself as an LLC
7. Get insurance
Forming an LLC can help protect your personal assets from lawsuits. But getting LLC insurance will help protect your business assets, too.
Learn how to start your business
NerdWallet has rounded up some of our best information on starting a business, including structuring and naming your company, creating a solid plan and more.
» MORE: How to start a business
Frequently Asked Questions
What does LLC stand for?
LLC stands for limited liability company.
Why choose an LLC?
LLCs are a common type of business structure because they are relatively easy to form and protect owners from being liable for business losses or missteps. LLCs also allow for flexibility in the way they are managed — members can manage the daily operations of an LLC or they can hire an outside manager.
What are the risks of an LLC?
If an LLC’s members engage in certain types of misconduct, a judge may choose to hold them personally liable for the LLC’s actions. In addition to this risk, members may still be required to pay self-employment taxes and any membership changes require the entity to be completely dissolved and reformed.
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